This newspaper’s report on Monday about the orthodoxy that informs the current interest rate policy raises a hugely important question: what is the cost of doctrinaire monetarist management? The RBI has increased short-term lending rates to 7.5 per cent, increased the credit reserve ratio and has started selling market stabilisation bonds. Hopefully, there will be no further action till the next scheduled policy announcement late in April. Of course, as we keep saying, inflation is an issue. Mind you, inflation alarmists will feel a little lost, come April when higher base figures from last year will automatically mean lower point-to-point WPI rates.But let’s assume the alarmist position. The point is whether interest rate hikes as a solution is a misconception, just as tom-tomming import duty reductions is. Lower duties won’t dampen local prices if global prices are high. Which is why wheat imports should have been freed earlier; there may have been a significant price-lowering effect. Now look at government’s own diagnosis (including Economic Survey pronouncements). Two things are being said officially. First, that primary products (15.4 per cent of WPI) are driving inflation. Second, higher primary product prices are being caused by factors like poor harvest in Australia, use of crops to produce ethanol, higher diesel cost, stagnant productivity, intermediation and seasonal weather conditions. How will higher interest rates help here?The case of manufactured product prices (bulk of WPI) is different. But even here, capacity will come on stream after about 18 months. Should one ruthlessly curb demand meanwhile? And will interest rate hikes actually achieve this objective? Barring real estate and capital market, interest rate hikes are unlikely to be effective and even in those two segments, there are supply-side constraints that could be eased through further reforms. Now consider the flip side of interest rate orthodoxy. It can be spectacularly unequal in its impact. While inflation remains relatively resistant to higher rates, the small borrower — whether in industry or outside — pays a disproportionate price. Big corporates can access overseas funds when domestic borrowing becomes costly, smaller industry can’t. In macro terms, there’s already a lesson. Narasimha Rao’s government panicked because of inflation, and it is now widely agreed that the RBI’s tinkering with notions of acceptable levels of inflation and subsequent hikes in interest rates choked India’s growth between 1994-95 and 1996-97. Will policymakers please take note?
