Higher-for-longer rates pose a peculiar problem
Interest rates will probably stay higher for longer not just in the US, but here in India too. It could restrain a revival in private investment and constrain what the government can spend
As nations, both India and the US have shared civilizational values, especially the unshakeable belief in democracy as a just and equitable political model. There is another critical area where commonality seems to be emerging: the path that leads from monetary policy to the political economy. The US central bank, the Federal Reserve, and the Reserve Bank of India (RBI) are both confronted with a quandary that has implications for the theatre of politics. Both central banks are under pressure to cut benchmark interest rates, but find their hands tied by an odd growth-inflation dynamic. Wall Street, for example, looks convinced that US inflation data for March—at 2.7%, up from February’s 2.5%—may prolong the wait for interest rate cuts. In the face of strong growth impulses and robust hiring numbers, the US Fed is likely to keep its principal policy rate—currently at 5.33%—higher for longer. This has sparked off a debate over the utility of restrictive rate structures and whether policy has been tightened sufficiently over the past few months to rein in growth impulses, consumption expenditure and their feedback loop with inflation.
India’s central bank faces a somewhat similar conundrum. RBI initiated rate hikes around the same time as the Fed in 2022, coupled with a bespoke liquidity play. This disinflationary strategy did yield dividends, but only up to a degree, given that Indian inflation right now is primarily a supply-side phenomenon. So, while the rise of India’s consumer price index has slowed from 5.7% in December 2023 to 4.9% in March 2024, its volatile elements remain elevated. The rate of food inflation, for instance, was 7.7% in March, slightly lower than February’s
7.8%. Concerns shadow the winter harvest; the prognosis of a harsh summer has spelt worries of crops in short supply, especially vegetables and pulses—though, if it happens in time, a Pacific pivot towards La Niña later this year could enhance monsoon rains. RBI acknowledges that volatility in food and fuel prices—the latter on account of geopolitical flashpoints—has put its disinflationary push at risk. An added wrinkle is our post-pandemic recovery in economic activity and a 7% GDP growth forecast for 2024-25. Minutes of the last monetary policy committee meeting reveal that its members view the current growth-inflation dynamic with some unease and would like to tread with caution. Or, higher-forlonger in India too.
This poses a peculiar problem for the Indian political economy. The government’s frontloading of capital expenditure, with spending on it from April 2023 to February 2024 having grown by over 36%, has failed to achieve the desired effect of inducing the private sector to invest and broad-basing the economy’s revival. With policy rates unlikely to go down anytime soon, the private sector might stay reluctant to open purses for longer too. While rates alone do not guide investment decisions, they do tilt the balance, as a higher cost of capital demands a larger return on capital employed to justify credit uptake. Unless markets for goods and services buck up to promise a significantly broader boom ahead, uneven private investment would keep job generation at sub-par levels. With rural stress also in evidence, this could dampen growth impulses as we go along, which would restrict the Centre’s revenue below what’s imperative for India’s development and welfare enlargement.