Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Charge of the rate reduction brigade - Outside View by S.S. TARAPORE
Charge of the rate reduction brigade

They are on the wrong track. A rate cut will erode the already falling savings rate, and hence the future capacity to grow

In the run-up to the Reserve Bank of India's Third Monetary Policy Review for 2015-16 on August 4, 2015, the interest rate reduction brigade will be active with loud beating of drums and blowing of trumpets. The present government, after making the right genuflections about the prerogative of the RBI to determine policy interest rates, will promptly start haranguing the RBI in public that the policy repo interest rate should be reduced.

Chief Economic Adviser Arvind Subramanian fired the first salvo in the middle of June by saying that real interest rates are "whopping" high. Arvind Panagariya, vice-chairman of the NITI Aayog, has been voicing the same view. Predictably, in the next few days, the minister of state for finance, Jayant Sinha and the finance minister, Arun Jaitley, will voice similar views.

Global developments

The global economy has experienced eight years of unprecedented quantitative easing with close to zero policy interest rates. Increasingly, there are strong expectations of a reversal of policy interest rates in the US in 2015 which could be one of a series of 'tantrums' that global financial markets are likely to witness. The Bank of International Settlements (BIS) has been unequivocal in its warning that global interest rates are too low and could pose growing risks to financial stability. The BIS stresses that policy normalisation should come sooner rather than later as debt burdens are rising to unacceptable levels with a build-up of financial imbalances. Claudio Borio, the much respected head of the BIS's monetary and economic department, summed it up as the financial system being one of "too much debt, too little growth and too low interest rates". The BIS warns that "normalisation of policies will be bumpy as low interest rates have given rise to a faulty debt fuelled global growth model".

Domestic outlook

A bird's eye-view of the domestic economy points to a real GDP growth rate in 2015-16 of around 7.8 per cent, which would be the highest in the world. We should be more than satisfied with this rate of growth but 'aspirations' of both the erstwhile UPA government as well as the present NDA government is for the magical double digit growth rate. It is unfortunate that the emotional call for a 10 per cent real rate of growth is so strong that ground realities are ignored.

A number of issues have to be factored in:

  1. We live in an increasingly integrated global economy and with sluggish global growth it is not realistic to expect the Indian economy to grow at 10 per cent.

  2. Gross domestic savings have fallen to 30 per cent of GDP and even assuming a capital-output ratio of 4.0, a 10 per cent growth rate would require a 38 per cent gross domestic savings to GDP ratio, assuming a current account deficit of 2 per cent of GDP.

  3. A low rate of interest militates against the need for a higher rate of savings.

  4. The 7.8 per cent growth projection for 2015-16 is premised on the services sector leading the pace of growth. The Index of Industrial Production as of May 2015 shows a growth rate of only 2.7 per cent. Again, with monsoon uncertainties, agricultural output would, at best, be around the average of recent years or even lower.

  5. The Consumer Price Index (CPI) inflation rate on a year-on-year basis for June 2015 is 5.4 per cent and tentative estimates for the target date of January 2016 point to an inflation rate of around 6 per cent.

  6. Indian exports have been a cause of anxiety for a number of months.

  7. There are clear signs of a deterioration of asset quality in the banking sector and there are lurking fears that the actual non-performing assets (NPAs) could be much higher than revealed.

Lowering policy interest rates

In this context, the call by government, industry and analysts for lower interest rates is totally inappropriate. Lower policy rates would sooner or later translate into lower lending rates but the malaise of the economy cannot be remedied merely by interest rate reductions. Moreover, policy interest rate reductions would feed into lower deposit rates which would lower savings in financial assets.

Ultimately, the RBI has to take the right call. One could equally argue that far from lowering interest rates the appropriate policy response should be to raise policy interest rates. It is better that the RBI is criticised for taking the right decision rather than taking the wrong one to please the powerful galleries, but be condemned by history for wrong decisions.

The constitution of the monetary policy committee, as recommended by the Financial Sector Legislative Reforms Commission (FSLRC), has been a contentious issue. The FSLRC recommends a seven-member committee composed of two RBI executives and five external members with a veto power for the governor. The committee chaired by the deputy governor, Urjit Patel recommends a five-member committee consisting of three RBI executives and two external members with no veto for the governor.

Subramanian recently claimed that the RBI and the government are on the same page. The issue is not only of who appoints the external members but more importantly the number of executives and external members. This leads to the issue of accountability. If the external members are in a majority there is no way accountability can be determined. Accountability is an executive function and not the function of the advisory. The sooner this is understood the better for a viable system.

Please Note: This article was first published in The Hindu Business Line on July 24, 2015.

This column, Maverick View is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Freepress Journal, is titled Common Voice.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.


Equitymaster requests your view! Post a comment on "Charge of the rate reduction brigade". Click here!


More Views on News

How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

Jun 10, 2017

Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

Dear PM Modi, India is Already Land of Self-Employed, and It Ain't Working (Vivek Kaul's Diary)

Aug 21, 2017

Most Indians who cannot find jobs, look at becoming self-employed.

The Key Factor Pushing Gold Up These Days (Outside View)

Aug 21, 2017

PersonalFN explains the chief factor pushing gold prices up of late.

How Unique Are the Companies You Invest In? (The 5 Minute Wrapup)

Aug 21, 2017

One of the hallmarks of successful investing is to look out for companies that have a unique and enduring moat.

You've Heard of Timeless Books... Ever Heard of Timeless Stocks? (The 5 Minute Wrapup)

Aug 19, 2017

Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.

More Views on News

Most Popular

A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

Aug 10, 2017

Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

The Most Profitable Investment in the History of the World(Vivek Kaul's Diary)

Aug 8, 2017

'Yes, it looks like a bubble. And, yes, it's like buying a lottery ticket. But there's something happening that has never happened before. It's an evolutionary leap in money itself.'

Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

Aug 8, 2017

Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

Signs of Life in the India VIX(Daily Profit Hunter)

Aug 12, 2017

The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

Bitcoin Continues Stellar Rise(Chart Of The Day)

Aug 10, 2017

Bitcoin hits an all-time high, is there more upside left?


Become A Smarter Investor In
Just 5 Minutes

Multibagger Stocks Guide 2017
Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
We will never sell or rent your email id.
Please read our Terms


Aug 21, 2017 (Close)