Dr. Sanjiv Agarwal

This is neither a festival bonanza nor a diwali blast from Reserve Bank of India. From common men’s perspective, Reserve Bank has given yet another blow (this time thirteenth in succession in last twenty months) by hiking interest rates by 25 basis points on the eve of diwali. The objective is to curb inflation (being unsuccessful in last twelve attempts) but it has certainly dampened people’s festive mood. However, policy also hints that there may not be further interest rate hikes.

Government and the central bank, both have miserably failed in containing inflation which, ideally can not be left to run loose. In the present scenario, when there is slackened global economic environment, slower economic growth and lack of strong financial reforms, a rise in interest rates will not help much but is likely to dent the economic growth without putting a break on inflation. India now projects an economic growth of around 7.6 percent, down from 9 and now 8 percent. One needs to appreciate that interest rate alone will not be able to control inflation caused primarily by high commodity prices. It will happen only when it is coupled with global oil prices softening, subsiding of food prices and enhanced food supply, manufacturing sector growth and reduced fiscal deficit. Higher interest rate will take a toll on economic growth which will soon become counter productive. Another problem is that regulators have now become astrologers as they forecast that inflation will come down to 7 percent by March 2011. How? There are no answers to it. Actually, growth is moderating on account of cumulative impact of earlier monetary policy actions and other factors.

Global crude civil prices are also expected to rise which will force go government to hike fuel prices further. This will only add fuel to inflationary fire. Also, higher interest rates will also be passed on by manufactures to consumers adding to inflation.

Higher interest rates on housing loans is expected to further harden the problems of real estate sector, though they may not reduce the prices of unsold inventory significantly. Credit off take is already slowed down and new projects are being deferred. Not only this even the primary market activities have slowed down and stock markets are behaving erratic with huge volatility. High interest rates, international turbulence and inflation will keep the markets volatile.

The only cheers brought in is by way of freeing of saving bank interest rates. Though two competition among banks will lead to some hike in saving bank rates by 2-3 percent, it will make funds costlier for banks, shrinking their net interest margins and adding to pressure on profitability. This will also make loans costlier. It will affect banks with large saving banks account more. However, every bank will have to offer uniform rate on saving deposits upto Rs. one lakh. We may see few interest rate slabs without any discrimination from customer to customer.

Another major step taken is towards removal of prepayment penalty on home loans so that if one opts to prepay to avoid interest burden, he may not be penalised, just because he is making a pre payment. On pre-payment charges being removed, benefit will be only to those select few who are in a position to repay before time ,ie those with some windfall liquidity or profit which are not of much needed at this point of time. Only a small percentage of home loans gets prepaid and a removal of prepayment charges (1 to 2 percent) may not lure a general home loan customer to prepay. However, it may lead to some increase in inter-bank shifting of loan accounts as ‘takeover of loans’ may increase.

RBI alone can not curb the inflation unless it is supported by government in addressing supply side bottlenecks in agricultural producing, commodities and food prices and related infrastructure. Also, inflation, interest and growth, all can not subsist together. Both inflation and interest rates will have to come down if economic growth has to move up.

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