Whose interest?

Whose interest?

The government is making an aggressive bid to drive down interest rates. Thursday's half-per cent cut in the bank rate by the Reserve Bank of India was the second in a fortnight. The steep one and half per cent cut in interest rates on the public provident fund and post office savings announced in the Union budget, it is hoped, will also have the effect of easing interest rates. Will it work? With the bank rate now at 7 per cent and the so-called floor set by small savings interest rates pushed down to 9.5 per cent, the scenario looks promising. More banks may follow the example of those private and public sector banks which announced reduced prime lending rates (and lowered their deposit rates) hot on the heels of the cut in the bank rate. So can industry look forward to a stable low-interest regime for a reasonable length of time? Or will this be another false dawn like the one that broke over the country last year?

A number of trends stress how crucial it is to bring down the cost of funds for domestic industry. The industrial slowdown has led to fears of another recession in some quarters. Capital investment is down. Competition from imports is growing. Employment creation has fallen from 1.9 per cent in 1991 to an alarming 0.04 per cent in 1999 and the new jobs are only in the private sector; the public sector is creating none. No one can quarrel with the objective of bringing down industry's cost of funds. But questions remain whether a low interest rate regime can be sustained and about the methods. The purpose of slashing interest rates on small savings is to bring down the level of the government's interest payments (which take half of gross revenue) and, in turn, to reduce government borrowings which squeeze out private borrowings from the market and are the major factor determining the level of interest rates.

Past profligacy, the accumulation of government debt, has led to desperate measures. That is the real explanation for the steep cut in interest on the main forms of savings of the working class and middle class. `Real rate of interest' calculations are misleading. In fact, interest at 9.5 per cent rate on small savings is just about 1 per cent above the rate of inflation of 8.4 per cent. Core inflation which reflects expectations of inflation may be a useful measure for monetary policy-makers. As far as ordinary people are concerned, it is inflationary experiences captured in headline inflation that matters. Therefore, having been compelled to take harsh measures, the government will have to be very watchful about inflationary trends, monitor the prices of essentials like edible oils where output has fallen and respond quickly to signs of price levels being breached. A combination of price inflation and falling earnings (from savings) would defeat expectations of a shift to equity markets and of higherconsumer spending both of which industry would like to see. A number of developments, including trends in domestic savings, will have to be carefully monitored. Monetary expansion could once again cause volatility in the exchange rate. The government's huge borrowing requirement and the growing demand for funds from industry must be met without either stoking inflation or putting pressure on interest rates.