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Tuesday, May 26, 2020

RBI proves interest rates are a sideshow

The value of rupee,inflation and even access to credit perform far less effectively as predictors of industrial growth for periods of upto a year.

Written by Subhomoy Bhattacharjee | Published: August 26, 2013 2:30:15 am

On Friday,this newspaper carried a front page story saying FY’14 first quarter growth rate will be less than 5 per cent. Beyond the immediate concerns about the sliding rupee the larger problem of the Indian economy is about its sliding growth rate. The actual data should be released this week.

A less than 5 per cent growth rate now means the economy will have to accelerate to at least 5.7 per cent in the next three quarters to reach 5.5 per cent,the RBI projection for FY’14. Since agriculture is doing well enough,it boils down to a guess on how the industrial sector will perform. This means it will be about pressing the right levers to make the industrial sector respond the fastest.

An RBI analysis carried in its annual report released last week shows industrial growth or IIP responds best to performance of core or infrastructure industries.

Interest rates,the value of rupee,inflation and even access to credit perform far less effectively as predictors of industrial growth for periods of upto a year.

This of course suits the central bank fine as it can say it is Raisina Hill which is goofing up on economic management.

Significantly,each of the past few policy documents of RBI,the quarterly macro-economic reviews for instance that accompanies the bank’s commentary on monetary policy,have carried at least one study which shows interest rates are far less effective than management of the real economy in order to push up growth.

The study in the chapter “Economic Review” too notes that “a 1.0 percentage point increase in core industry growth results in the acceleration of IIP growth by about 0.59 percentage points. Further,inflation,real interest rate and real exchange rate do not significantly influence IIP growth in the short term”.

The UPA government has definitely made a mess of its handling of the infrastructure sector. Since May 2009 when this government came to power of the 36 months the sector has grown in just half the months. But the central bank too has played along. It has kept exposure to infrastructure finance companies at 15 per cent of the banks’ capital fund. The most stringent regulations on credit exposure for banks are for financing of infra companies,directly or through NBFCs.

Check out its master circular ( To then argue that core sector should grow fast enough for industrial growth to bounce back is a clear case of circular reasoning.

It is this mindset the new Governor Raghuram Rajan will have to dismantle from next week.

Subhomoy is a Deputy Editor based in New Delhi.

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