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Does RBI's policy on interest rates make sense?
Thu, 8 Jan Pre-Open

As the economic data on inflation suggests some easing, the pressure on Mr. Rajan to cut interest rates seems to be mounting up from all sides - be it the Government or the corporate sector. However, not giving in to this pressure, Mr. Rajan has made his priorities very clear - inflation control and stable growth, rather than just growth.

There is no dearth of arguments against this stand. The need to boost demand as interest rates come down is one of the many. While the current data on inflation may warrant some cutting, that can not be the sole basis of cutting the interest rates. Instead, such a move could turn out to be extremely short sighted. This is because supply side issues - one of the key reasons that can increase inflation, are yet to be addressed. A lot of sectors are already facing problems of stressed assets and over capacities. As major reforms are yet to be unleashed; an early cut can over stimulate the economy and can lead to asset bubbles rather than increasing real demand. Also, in a scenario when falling oil prices and a likely increase in the US interest rates may impact money inflow in the Indian markets, high interest rates could be the only way cushion to soften the blow.

Further, that high interest rates have blocked the growth is a fallacious assumption we believe. Had that been the case, developed economies with interest rates close to zero would have been the top growing economies. The shot that India needs to pick up the growth is not a rate cut, but clear policies and reforms. While a cut may seem rewarding in the short term, we need to think long term. Unless there are clear signals of stable low price scenario, it is better to adopt a wait and watch policy.

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