Inflation at zero per cent points to the disastrous effects of the policy of managed interest rates

No matter what index is used, the Indian economy is showing zero inflation. The annualised seasonally adjusted (SA) figures for three measures of inflation for the latest quarter are as follows (unadjusted figures in brackets): WPI, 1.1 (2.6); WPI manufacturing, -1.0 (-0.1); CPI, 1.6 (5.6).

Non-farm bank credit has also slowed to a crawl, and at 7 per cent (the unadjusted is at 1.1 per cent) it is at one of the lowest levels in the last decade; and industrial production is more likely at zero growth rather than the year-on-year figure of 2.5 per cent, or the latest quarterly (not seasonally adjusted) figure of 6.4 per cent.

The raw inflation figures show that inflation is at a historic low; the seasonally adjusted figures suggest that it is even lower, and without planning! We have reached the much-desired figure of zero inflation. Ordinarily, this would be a cause of celebration. But these are not ordinary times, and the figures are suggestive of something terribly wrong with the conduct of macro and interest-rate policy in India.

What else does zero inflation reveal? Simply, that the economy is weak, very weak. And what are the reasons? Globalisation. The world economy is going through its worst collective downturn for only the second time in the last 55 years; the last such slowdown occurred in 1973-74 when the oil price was quadrupled by OPEC.

Some commentators have argued that since exports are only a small part of our GDP, approximately 10 per cent, India is not that vulnerable to global downturns. This is false on at least two counts.

First, what matters is not the size of traded goods, but the size of what can be traded; and with the decline in tariff and non-tariff barriers, the share of tradeables is now very large. Second, if exports are growing at 20 per cent (like last year), then as a very rough approximation they were adding at least 1 percentage point to GDP growth.

Exports are presently (latest quarter) declining at approximately 15 to 20 per cent annual rate (the raw data shows an absolute decline of 17.5 per cent in just the second quarter). In other words, more than 1 per cent decline in aggregate GDP growth is due to the global slowdown.

Are there any domestic responses to a global slowdown? If it is a market economy, i.e. one with few controls and/or distortions, then there is precious little that individual governments can do. But if an economy has been “blessed” with past mistakes, then the mere removal of these distortions can be a strong source of growth. This is the happy predicament in which Indian policymakers find themselves today.

The distortions are several and legion. In India, there is now a virtual industry of pronouncements to help the economy — the need of the hour, second-generation reforms, etc. The typical is the recent pronouncement by the dean of industry lobbyists, CII’s Tarun Das (The Economic Times, August 21): the government needs to concentrate on three areas — public infrastructure, disinvestments and exports. No mention is found in most expert dossiers of the biggest distortion, and therefore the biggest source of future and “free” growth: the role of managed, and exorbitantly high, real interest rates in the economy.

It is important to investigate as to why Indian industrialists have not been demanding the removal of mismanaged interest rates. A real borrowing rate of close to 10 per cent, let alone the 15+ level for most firms, would kill any entrepreneur.

Yet I have noted in several forums over the last five years that industrialists are mostly amused by my tirades against managed interest rates. Why should they not be championing the cause of competitive interest rates?

For the simple reason that the major industrialists in India have never suffered the yoke of extortionary real rates; being card-carrying members of the BLIP (bureaucrats, left-intellectuals, major industrialists and politicians) brigade, they are masters of the system. They do not suffer from high rates; relations with politicians, NPAs of banks and lack of good bankruptcy laws allow them to borrow, and never repay. One area I am in agreement with Marx.

So, the next time you get worked up about the high cost of borrowing in India (done in the name of the poor, or in the name of government pensioners who deserve an annual 12 per cent real return, or other such perfidious nonsense peddled by our politicians and old-fashioned economists), government bailouts of banks and mutual funds, non-performing assets, and wonder why nobody is bothered, pause. Get worked up also about the lack of a market economy in India, lack of economic freedom, and the monopoly presence of state capitalism.

Zero inflation points to both the cause and the remedy for most of the economic ills. The governor of the Reserve Bank of India, Dr Bimal Jalan, had correctly noted almost three years ago that what ailed the Indian economy was the “structure of interest rates”. This was Bimalspeak for the fact that interest rates were sticky, and that there was a scam in the setting of interest rates.

The scam was in the form of the government setting up high rates for so-called “small and old savers” (a story bought by most politicians and several present and past policymakers) who “contribute” to these postal deposit schemes. The scam was in the “use” of these savings — all towards highly unproductive and corrupt state expenditures.

Full credit to the finance minister, Mr Sinha, for realising this scam and in not being taken in by the fashionable speak of some old-fashioned economists who attributed high real interest rates to high fiscal deficits.

As noted in the article “Capital markets and the RBI” (August 18/August 19), India has had high fiscal deficits, in the range of 8 per cent to 10 per cent, for the last 20 years. This time, real interest rates have ranged from 0.5 to 15 per cent i.e. high and constant. Fiscal deficits prevailed with real interest rates of 1 per cent, 2 per cent, and now close to 12 per cent.

Indeed, such high administered rates fuel higher deficits — interest payments as a fraction of the deficits were only 25 per cent at the time of the financial crisis in 1990-91; today they account for almost the entire consolidated fiscal deficit of the Indian economy yes, close to 10 per cent of GDP.

As an end to the scam, and a prelude to market determination of interest rates, a government committee was constituted to provide a roadmap of reforms. If Business Standard is to be believed (“Stemming the drain”, August 14), this committee has recommended that the savings deposit rate be tied to the bank rate!

Clearly, the control freaks are not only not relinquishing control, they are expanding their 50-year-old freakish empire. It is hoped that this RBI- housed committee will negate this recommendation and others like it, e.g. tying the savings deposit rate to the government securities rate. Deposit rates should be set by the needs of the savers and investors; if it is to be administered, it is best to set it at a discount to the prevailing inflation rate.

There is only one answer to the problems of the Indian industry — competition with China. And, one answer to India having a decent chance of finding its due place among nations (and making my forecast that this is India’s decade come true): competitive cost of capital. Let the games then begin.

(The author invites comments on the website www.oxusresearch.com where an archive of articles is also available)