Tight monetary policy, high interest rates slowed growth
MUMBAI: High interest rates and tight monetary policy caused India’s economic growth to slow at a time when the world economy had embarked on a synchronous recovery, said the Economic Survey. According to the survey, till early 2016, India’s growth had been accelerating when other countries were in the midst of a slowdown. This dynamic later changed with Indian growth “decoupling” from global growth.
The survey, authored by chief economic adviser Arvind Subramanian, outlined five factors for the divergence: a tight monetary policy, demonetisation, GST, the twin balance sheet problem, and high oil prices.
The survey said that until the middle of 2016, real policy interest rates (those adjusted for inflation) had dipped following a global trend. Most countries continued to see that trend with rates in the US falling on an average by 1 percentage point between July and December 2016. However, average real interest rates rose by about 2.5 percentage points during the same period in India.
“This tightening of monetary conditions contributed to the divergence in economic activity in two ways. First, it depressed consumption and investment compared to that in other countries. Second, it attracted capital inflows, especially into debt instruments, which caused the rupee to strengthen, dampening both net services exports and the manufacturing trade balance,” the survey said.
According to Gaurav Kapur, chief economist at Indusind Bank, higher interest rates do impact consumption demand, and thereby growth. “But it can’t be the primary reason. The bigger issues were of the twin balance sheet problem, demonetisation and GST, which disrupted supply chains,” he said.
In the previous monetary policy in December, the Reserve Bank of India’s (RBI) monetary policy committee (MPC) kept key interest rates unchanged, noting risks to inflation, but expressed optimism that the slowdown in economic growth had bottomed out. Inflation measured by the Consumer Price Index (CPI) accelerated to 17-month high of 5.21% in December from 4.88% a month ago. This was sharply higher than the 4% medium-target for the MPC.
“The policy rates can be expected to remain fairly stable if the inflation rate does not deviate much from its current levels,” the survey said. However, it also said that persistently high oil prices, at current levels, remain a key risk and would affect inflation, the current account, the fiscal position and growth, and “force macroeconomic policies to be tighter than otherwise.”
The MPC will meet next week to decide on policy rates.