Why Raghuram Rajan should go easy on India's money policy

The Asian Development Bank (ADB) in its annual outlook report released last week projected India's economic growth rate surpassing China’s to touch the seven point eight per cent mark in 2015-16.

Similarly, the finance ministry’s latest Economic Survey has emblazoned across its cover a graph showing the Indian economy, which has been growing at a much slower rate than the Chinese until now, shooting past the dragon in 2015-16. While this comparison with China is heady wine that fuels the feel-good factor there is a huge amount of spade work that needs to be done before the elephant can catch up with the dragon. Official figures released on Tuesday showing the growth rate of the infrastructure industries comprising steel, cement, power, fertilizer and oil sectors slowing to a crawl of one point four per cent serves to drive this point.

Governance

While there is no doubt that the new government has got down to the business of governance and reviving the economy with great gusto it has inherited a huge mess on the economic front.

Finance minister Arun Jaitley has done well to step up investments in the battered infrastructure sector even if it has been at the cost of pushing the stiff fiscal deficit target by a year. This present versus future argument is perhaps best surmised by British economist Sir John Maynard Keynes’ famous quote : “In the long run we are all dead.’’

The fact that corporate investments have all but dried up makes it imperative for the government to fill this gap by higher investments in railways, roads, ports and power projects to spur growth and create employment. The 52 per cent jump in the planned outlay for the railways will go a long way in giving a fillip to the economy and provide much needed logistical support to the manufacturing sector in the form of quicker and cheaper movement of goods vis-à-vis road transport.

The country’s fiscal policy is rightly focused on promoting economic growth and creating more jobs. However, the monetary policy managed by the RBI appears to be lagging behind in complete disregard to Keynes’ wise thought. India Inc has been unequivocal in its criticism of the RBI’s hawkish monetary policy and has been blaming the central bank for choking consumer demand and corporate investments with its high interest regime.

The finance ministry is also of the view that there is a need for reducing interest rates to rev up the growth rate and generate more jobs. In fact, Jaitley and his predecessor P Chidambaram are on the same page when it comes to a trade-off between unemployment and inflation.

Growth

It is quite evident to those who are in touch with ground realities that unemployment does more harm than mild inflation to an economy or society.

However, the RBI governor Raghuram Rajan is seen to be following the same tight money policy as his predecessor Duvuri Subbarao aimed at controlling inflation even if it happens to be at the cost of dampening economic growth.

With inflation coming down due to the sharp decline in international prices of crude and other commodities such as coal, a golden opportunity is being missed to reduce interest rates and switch to an easy money policy. This would help to create much-needed jobs for the youth who graduate from our universities every year.

But the RBI in its wisdom has chosen to adopt a cautious stance with two meager interest rate cuts of zero point two five per cent each. This has turned out to be a case of too little, too late. Banks do not seem to consider the rate cuts significant enough to reduce the interest rate on loans to consumers and corporates.

According to the Economic Survey, as many as one-third of 3,700 companies listed in the stock market did not earn enough to repay the interest on their loans during 2013-14. Indian corporates also have a much higher debt-equity ratio than other countries and most of this debt has been raised from public sector banks. Interestingly, the Survey highlights the fact that unfavourable market conditions, and not regulatory clearances, are stalling a large number of projects in the private sector. These include steel, cement, garments and food processing which in turn has a crucial role to play in raising farm incomes as well.

Income

Most of the stalled projects in the private sector relate to manufacturing and since these are impacted by unfavourable market conditions an easy money policy would help to raise demand and rev up the growth rate which would mean more jobs and income for the workforce. The stalling of projects has adversely impacted the balance sheets of the corporate sector and public sector banks as a result of which fresh investments are not taking place in the economy. In the case of the public sector, on the other hand, most of the big ticket projects have been held up due to the lack of regulatory clearances and are related to infrastructure such as highways, ports and power plants.

This is a reflection of the policy paralysis that had set in during the scam-battered Manmohan Singh regime but things have started to improve with the new government taking over.

CSO figures show that from a peak of 24 per cent in the last quarter of 2009-10 the rate of capital formation in the Indian economy came down to nil in some quarters of 2013-14 and 2014-15. There has been a sharp decline in investment during the last five years and the RBI needs to lend a helping hand to revive the cycle.