(MENAFN- Khaleej Times) T he reserve bank of india cannot escape blame for using sloppy logic and doubtful data to take a wrong call in maintaining interest rates near the highest levels in modern times. RBI's inaction has jolted financial markets and hit business confidence further.
To be fair, the central bank had reasons to think that monetary loosening is a bad idea for now: consumer price inflation past 10 per cent, the government borrowing with both hands and the possibility of a global "event shock" that would cause other central banks to flood the market with liquidity in response - which RBI rightly fears would flow into commodities, raising commodity prices and domestic inflation.
All this is true. And several commentators have praised the central bank and its Governor for not being browbeaten by short-term interests, for standing firm in the face of incessant pressure and for restoring faith in independence of the monetary authority.
The fact, however, remains that the RBI has taken a wrong decision. It should have reduced lending rates. Economic players needed something positive to bolster confidence and revive activity. Asserting independence of the central bank and springing a surprise could hardly be the top priority in times like this. As regards inflation, the central bank should have looked at core inflation - the change in non-food, non-fuel prices which are most insulated from supply side factors-the only sort of inflation that a monetary authority can, and should, control. Core inflation has consistently stayed low this year, and was below five per cent in May. High headline inflation, which the RBI cited as a reason for its refusal to act, is driven largely by pulses, fruits and vegetables. Fixing these prices is not the province of the monetary policy.
RBI uses wrong data when it says that "real effective bank lending rates, though positive, remain comparatively lower than the levels seen during the high growth phase of 2003-2008". As Surjit Bhalla pointed out (FE 20/6), current real lending rates are higher than the average rates in that period. Using this wrong data, RBI reasons that since real interest rates were higher in the high-growth 2003-08 years, interest rates have a limited role in explaining today's lower growth. What it forgets is that India's 2003-08 growth was surely lifted by much higher global growth and consequent higher exports. And Indian companies could raise large sums in local equity markets and debt in overseas markets to keep interest costs down.
The RBI's claim that factors other than interest rates have contributed to the growth slowdown is unexceptionable. But equally, one could argue that the link between 'policy' rates and inflation is not as immutable as the RBI would contend. In fact, it has been pointed out repeatedly that trying to combat shortage-driven inflation with monetary policy was a futile exercise, that it will only stifle growth without curbing prices. And that is exactly what has happened. If low interest rates may at times play only a small role in promoting investment, it could also be argued that high interest rates may have only a small role, if any, in containing inflation.What the economy needs above all is to get investment going.
There is an opportunity on that front. The decline of the rupee has restored some competitiveness to the economy. Meanwhile, global capital is looking for a safe haven away from troubled western economies. The Reserve Bank could have done its bit by changing the narrative of low returns. It has missed the opportunity.
Views expressed by the author are his own and do not reflect the newspaper's policy
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