22.6.16

Get real on interest rates: RRR


A day after media reports presented the Centre's view that RBI chief Raghuram Rajan may have been “behind the curve“ on interest rates, the outgoing central banker launched his strongest attack ever on proponents of softer rates and warned that experimenting with macroeconomic policies would hit the poor hard.
Although Rajan has less than two and a half months left in his term, he chose a speech at the Tata Institute of Fundamental Research to launch a feisty defence of the RBI's commitment to lower inflation and to lay out the course for his successor. This was his first public address after announcing his intent to return to academia after September 4. “We had gotten used to decades of moderate to high inflation, with industrialists and governments paying negative real interest rates and the burden of the hidden inflation tax falling on the middle class saver and the poor,“ he said. The RBI governor also defended his `deep surgery' in the banking system, saying the problem with public sector banks had come to a head much before his move to clean up balance sheets and he would come up with lending numbers to back this statement. Besides calling out industrialists and the government, Rajan attacked economic advisors who were pushing RBI to cut rates on the grounds that India needs unique monetary policy solutions. “Decades of studying macroeconomic policy tells me to be very wary of economists who say you can have it all if only you try something out of the box. Argentina, Brazil, and Venezuela tried unorthodox policies with depressingly orthodox consequences,“ he said.
According to the governor, rather than lobby for rate cuts, industry could bring down borrowing costs by improving the loan recovery process.
Rajan warned that hyperinflation destroys middle class savings in bonds and fixed income and causes people to lose faith in money.“ As people lose faith in money , barter of goods for goods or services becomes the norm; How much of a physics lecture would you have to pay a taxi driver to drive you to Bandra; more over would the taxi driver accept a physics lecture in payment; perhaps you would have to lecture a student, and get the student to sing to the taxi driver...“ said Rajan.
According to Rajan, rather than experiment with macro policy , which brings risks that the unprotected poor can ill afford, he has chosen to innovate on micro economic policy such as those that define the business and banking environment.“Not only do we have less chance of doing damage if we go wrong, but innovative policy may open new paths around old bottlenecks,“ the governor said. Rajan pointed out that for two decades the interest rate has consistently been seen as a painless pathway .“Flipping through a book of cartoons by that great economist, RK Laxman, I found one that indicated the solution for every ill in 1997 when the cartoon was published, as now, is for the RBI to cut interest rates by a hundred basis points. Arguments change, but clever solutions do not,“ said Rajan.


The governor who has been under attack from industry for his clean-up of bank balance said lending by PSU banks was constrained much earlier as banks struggled with stressed borrowers. He said the slowdown in credit could be seen as far back as early 2014 and it has been particularly acute in respect of bank lending to industry.
Speaking on the impact of the referendum in UK going in favour of Brexit, Rajan said it would be bad for UK's economic growth and could cause some of the periphery members of European Union to consider dropping out. “Some people have even gone to the extent of arguing that the decision which British make may be an advance call on US elections. As you know US elections are also fraught with potential risk based on who may win,“ said Rajan. The governor had earlier commented on how the Brexit vote and the political discourse in the US was due to loss of middle-class jobs.

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