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| Focus on interest rates | | The most important decision facing the new govt concerns the economy. Instead of a stimulus package, lowering interest rates would be a better idea |
| Business Standard / New Delhi May 18, 2009, 00:52 IST |
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Perhaps the most important decision that the Prime Minister will have to take after Cabinet formation concerns the economy. There has been talk of another stimulus package, but that would be barking up the wrong tree. If the packages that have been announced so far have done little to reverse the slowdown of the past eight months, then what can be expected from another instalment of incentives for business? The far better course would be for the government to focus on lowering interest rates another notch or two, with as much dispatch as possible. Unlike stimulus packages which tend to focus on a few sectors, especially those with strong lobbies, a general interest rate cut helps all sectors. It also happens to be the case that, while one commercial bank after another has been announcing interest rate cuts, the effective rates in the market have not fallen as much as the Reserve Bank’s policy rates have. There are many reasons for this, but it should be the government's and RBI’s combined effort to nudge them lower by announcing more policy rate cuts. Unlike the stretched fiscal situation, which argues against more spending decisions, there is room in the policy rates for some more cuts and this leeway should be put to good use.
If any one sector needs help, it is the export sector. While industrial production has been falling, the fall has been led by export-driven sectors like textiles, food products and leather. Food products production, for instance, fell by an astounding 36 per cent in March, mirroring the 33 per cent fall in exports as a whole in the last couple of months. Indeed, with its 9 percentage point weight in the industrial production index, it is clear that food products single-handedly explained the 2.4 per cent drop in industrial growth in March; without it, the index would probably have shown an increase of just under 1 per cent. The problem, of course, is that the world trade situation is so depressed (to cite one instance, China’s exports have been falling by 22 per cent) that there is little that the government can do in the short run.
The price incentives that are transmitted to exporters through currency rates cannot be changed by much because the rupee has already fallen by about 20 per cent against the dollar. And the only element of “infrastructure” cost that can be lowered in the short run is the cost of money; all others (like power tariffs, freight rates, etc) involve medium- to long-term action. Once again, this points to the need to drop interest rates.
While there is no immediate danger on the inflation front, the government should keep in mind the possibility that excessive liquidity pumped into the system through more incentive packages and an ever-increasing fiscal deficit could show up at some stage in higher prices. Already, the vast sums of money that have been pumped into the world economy by the developed countries have found reflection in an increase in stock prices in many markets, commodity prices like oil (which has seen a 70 per cent price surge despite abundant supply), and shipping rates—although all the developed economies continue to be gripped by recession. While it would be wrong to seek fiscal tightening in a year when there is growth recession, the government should cap the deficit at its existing level and look at other, structural reforms that will help the economy achieve efficiencies and productivity gains.
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