High rates squeezing investments? Not quite

NEW DELHI: When growth falls, it is usually expected that the central bank will cut interest rates to boost demand and spending.

Reserve Bank of India (RBI) governor Raghuram Rahan, perhaps, was acutely conscious of the growing chorus of demand for an interest rate cut to aid investment and boost growth.

Rajan, however, chose to be on the side of price control in the growth versus inflation debate. He kept interest rates unchanged withstanding mounting pressure from business leaders to cut interest rates. Companies have been arguing that steep loan costs upset capacity expansion plans.

The argument: bank lending rates were still at par than what it was during 2006-08, India’s high-growth phase. So, the reasons for slowdown lay elsewhere, not just on high borrowing costs.

Between 2006 and 2008, the RBI’s repo rate—the rate at which it lends to banks—hovered in the range of 7-8%, not very different from the current 8% interest rate.

If the clamour for a rate cut during 2006-2008 was low, it was because products were flying off shop shelves as people spent more aided by high income growth.

Cut to 2013-14, the reverse appears to be happening.

Factory output showed no increase during April-January 2013-14 compared with 1% growth in the year-ago period.

“This stagnation in growth over two years reflects subdued investment and consumption demand. This has resulted in contraction in production of capital goods and consumer durables in the current year,” the RBI said in its “Macroeconomic and Monetary Developments 2014-15” report released last week along with the monetary policy.

Output of metal products, machinery, motor vehicles, food products, gems and jewellery have all recorded declines.

Domestic passenger vehicle sales declined for the second consecutive financial year in 2013-14 as a sluggish economy, high inflation and fuel costs put brakes on what was once the fastest-growing market in the world.

“Household consumption demand has failed to pick up despite the expected boost to rural incomes from an above normal monsoon,” research agency Crisil said in a recent report.

According to advance estimates of national income, India’s private consumption growth slowed to 4.1% in 2013-14 from 5% in 2012-13. High inflation and weak income growth have weighed down on consumer goods output, which has fallen by 2.7% so far.