The agonising
interest rate hikes for nearly two years broke the back of Indian economy.
Interest rates climbed 375 basis points. That was indeed the last straw for all and sundry!
If for any reason, the interest rate doses hadn't been prescribed, the
stubbornly high inflation at over 9 per cent throughout last year would have definitely created havoc in the lives of 1.2 billion people. So when Subir Gokarn, deputy governor of the Reserve Bank of India (RBI) last week uttered the much awaited official line that "the monetary cycle has peaked", there was no one around to join him in the celebration. And why should anyone? The wreckage from the interest rate hikes is strewn all over the economy.
The biggest casualty is the country's
gross domestic product (GDP), which is in danger of plunging below 7 per cent in the current fiscal from a projected 9 per cent at the start of the year. Households are the worst affected; abnormally high food inflation has eaten into their incomes and rising home loan EMI toppings have made their life more miserable than in the past.
There was no escape for India's billionaires either who over-leveraged themselves by expanding capacity not only in India but also abroad through big ticket billion dollar acquisitions. They are now staring at a slowdown in India and possibility of a recession in global markets.
What 2012 holds for the Indian economy
Today, many of the
entrepreneurs from high growth sectors like aviation, real estate, telecom ancillary, SMEs are knocking on the doors of bankers with a begging bowl. Gokran's words will give them some comfort after all, but there is no sign of pain going away in the near future.
The RBI, scheduled to meet on January 24, is expected to maintain a status quo in interest rates or press the 'cut' button as inflation fears (especially food inflation and not the core inflation that excludes food and oil) are now receding for the first time.
The downhill journey of interest rates from the current peak will take quite a long time. But the bigger question is - Is the journey to rock bottom interest rates in India miles away?
The cost of funds in India is still very high compared to neighboring China or the developed world.
India's benchmark policy rate - that determines the interest rate - is currently at 7.5 per cent, whereas China's rate stands at 6.56 per cent. Japan, as we all know, have a zero per cent interest rate. US have its benchmark interest rate at 0.25, UK at 0.50 per cent and Euro area has roughly around 1 per cent.
If India aspires to be economically strong, it has to have a lower interest rate regime to encourage entrepreneurship as well as domestic consumption. In fact, the road to reach even the pre-April 2009 level for benchmark interest rate in India - at 3.25 per cent - is a long one.
Reason?
Food inflation could resurface as supply side issues remained unresolved. There is not much focus on farm productivity, logistics, cold storage, weather forecasting etc.
Also, the fear of imported inflation (oil imports) is very much on the radar as domestic currency is vulnerable against the US dollar due to inadequate supply of stable FDI dollar inflows and higher imports (outflow of dollars) than exports (inflow of dollars).
So, it's back to higher inflation, which means higher interest rates for the economy.
The biggest danger of all is from the
widening fiscal deficit. The fiscal deficit is actually expected to widen from the projected 4.6 per cent to 5.6 per cent in the current financial year.
A high fiscal deficit and a falling GDP is a sure recipe for disaster. The events could unfold something like this - a higher fiscal deficit will result in increasing the money supply in the economy, which in turn will fuel inflationary pressure and subsequently higher interest rate to tame the monster.
Clearly, it is not yet time for celebrations!
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