High rates can constrain capacity push up inflation

The current regime of high interest rates that are aimed at curbing prices could in the long run lead to high inflation as production capacities would come under pressure

The current regime of high interest rates that are aimed at curbing prices could in the long run lead to high inflation as production capacities would come under pressure. R Gopalan,secretary,department of economic affairs in the finance ministry believes that an aggressive monetary policy could also impact growth. In an interview with Surabhi,he also discusses the nuances of Budget 2012-13. Excerpts:

Do you think it is time for RBI to cut interest rates?

Theres no yes or no answer. RBIs decisions are ultimately based on a number of factors,including the momentum of inflation,growth,industrial growth as well as disaggregated data and external factors like borrowing,fiscal deficit and coupon rates. So there are a whole host of things they look into. The RBI also looks at future trends in crude oil prices and corporate profits.

But there is also another side to this what is the comfortable level of inflation is a big issue that needs to be decided and there are differing viewpoints on it. But growth has come down to 6.9 per cent for 2011-12. A study of about 2,300 companies shows that corporate profits have been hit largely because interest costs have almost trebled. When profit margins shrink,it affects the perception of investors. It induces caution,which is good. At times,it can also be very harmful for the kind of environment it creates.

Also,growth is a major driver of non-IT services. If we dont push up growth to 7.6-7.8 per cent next year,investments wont take place and there will be a capacity constraint. This,in turn,will push up inflation. So from the viewpoint of growth and containing inflation,we need to have a relook at the interest rates. This is the point that is being stressed by the Ministry of Finance.

Is there a worry about inflation resurfacing?

Right now,we are not looking at capacity augmentation as it takes about a year to build. But due to many factors,capacity has also shrunk in the last two years. The potential output has fallen,so we need to increase it,without which there will be inflation.

Do you see the scare on short term external debt due to euro zone crisis abating?

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There was a time when we were worried that deleveraging will take place and credit will dry up. But keep in mind,our total trade credit is only 18-19 billion half of which is from euro zone banks. This is not a big number. Also,of late we are getting views that deleveraging is not as serious as people think it is,and the Indian system can easily handle it.