But there's no denying interest rates are important
Not surprisingly, given the nature of its previous communications, RBI has chosen to put the onus of fixing matters on the government while outlining the state of the economy on the eve of its monetary policy review. While pointing to the professional forecasters’ median outlook, RBI says this has lowered FY13 GDP outlook from 7.2% earlier to 6.5% now while the inflation outlook has gone up from 6.9% to 7.3%. As a result of this, RBI concludes the economy can be revived only by policy actions to encourage investments—and lest you think this means a rate cut, RBI clarifies this means removing constraints to FDI and addressing bottlenecks in the infrastructure space, it means creating enough fiscal space to give PSU investments a big push, to “provide space for monetary policy to help sustain growth while keeping inflation under control”.
No one can quarrel with RBI’s prescription but the problem is that its solutions—fixing the fisc and overcoming policy paralysis—can only be undertaken in the medium-to-long term though, there is no doubt, a diesel price hike would give indications the government is serious. Meanwhile, as RBI points out, Q1FY13 growth fell to a 29-quarter low in terms of q-o-q growth; investment intentions have moderated from R3.9 lakh crore in FY11 to R2.1 lakh crore in FY12 and even less in FY13. RBI may be of the view that interest rates don’t make as much of a difference as ‘policy paralysis’ but the fact is interest rates matter a lot for smaller firms—Axis Bank research shows interest-to-sales are over 8% for small firms versus under 2% for large firms; interest-to-PBDIT is up dramatically for groups like food products (23.2% in March 2010 to 43.1% in March 2012), cement (8.7 to 13.5%), hotels (28.9% to 40.1%), and so on. In short, there are sectors for whom ‘policy paralysis’ is the binding constraint and there are sectors for which interest rates are the problem. If RBI and the government don’t do what they have to—after focusing on ‘core inflation’, RBI is suddenly focused on WPI and CPI which are influenced by food inflation where monetary policy has no role—stagflation seems certain. Which means the poor, who need economic growth the most to be able to counter the impact of higher food prices—this can be countered only by government reducing supply constraints in agriculture—will suffer the most.