Monetary placebo

Rate cuts won?t revive India?s stalled growth

India’s latest interest rate cut won’t revive growth. The central bank’s quarter-percentage point reduction in the policy rate, to 7.75 per cent, is just as futile as the last one almost a year ago. GDP will pick up when New Delhi curbs its own profligacy and improves the investment climate. The February budget may be the current government’s last chance to do both.

If companies aren’t investing, it isn’t because monetary policy is too tight. With 10.6 per cent consumer-price inflation, the base rate for borrowing in 10-year bonds was already negative in real terms before this last rate adjustment. Rather, the government’s quest to fund itself is crowding out the private sector. Banks are forced to buy up government bonds, meaning two-thirds of what households save in a year is reinvested in public debt.

Bottlenecks choking growth are also in need of attention. A debilitating coal shortage is hurting electricity production. Meanwhile, road builders are wriggling out of contracts with the highway authority on the pretext that the environmental clearances promised to them are taking too long to materialize. Such factors help explain why GDP growth for the financial year is expected to slow to a 10-year low of 5.5 per cent.

Deep interest-rate cuts are currently impossible because of inflation. Rural wages are rising at an annual 18 per cent pace. If more money isn’t matched with greater investment and output, the result would merely be a further boost to imports, widening India’s 5.4 per cent current account deficit. For now foreign investors are helping to finance that through their purchases of Indian stocks and bonds, but it would be unwise to rely on that, especially if India’s broader economic improvements don’t take hold.

Growth thus depends on what New Delhi unveils in February. Finance minister Palaniappan Chidambaram has promised fiscal consolidation and other reforms. If he avoids the temptation to indulge instead in vote-buying populist measures that increase the government’s spending commitments, there may be hope not just of another rate cut, but of a recovery too.