WE ARE at a remarkable juncture of history when double-digit growth is being witnessed everywhere, be it exports, services or industry. The only laggard here is agriculture. The critical question at this stage is whether by following a tight money policy and making credit expensive and unavailable to a section of entrepreneurs and households, are we going to achieve higher growth in agriculture or are we instead, going to shoot ourselves on the foot by stifling growth in other sectors.
If curbing inflation is our sole objective, we need to first understand where the price pressure is coming from. And, whether this could be controlled by reducing money supply and squeezing credit availability. A quick look at the statistics shows that the overall inflationary trend has been primarily driven by high prices in the primary sector. The growth rate of Wholesale Price Index (WPI) for primary articles in last three months (Jan, Feb, March 2007) stood at almost 10%. Is there any connection between the agricultural prices and the interest rates?
The answer is ‘No’. By hiking the interest rates we are not curtailing inflationary pressures rooted in the supply shortfall in agriculture. Rather, by reducing the lendable resources of banks, the availability of funds to farm sector will be squeezed — an area where there is a crying need for funds. The focus instead should have been on effective implementation of the programmes dedicated to the agriculture sector and the outcome of the increased outlays allocated in the budget to this sector.
A long-term action plan for the agricultural sector should be drawn up by the government to put it on a high and stable growth path. The action plan should address the issues of low farm productivity, volatility in production and poor supply chain infrastructure. The government should go full steam ahead with the structural reforms that would bolster the supply side.
Whereas, by taking such drastic monetary measures, one would fail to contain the inflationary pressures and instead, current positive growth momentum would get adversely affected. Higher interest rates would make their impact felt mostly on housing, consumer durables and automobile loans.
Housing which on one hand, is a key driver of economic growth and on the other a basic necessity of life, will be hit the hardest. Housing loan cost in past one year has gone up by almost 4 to 5 percentage points. This, combined with a sharp increase in the real estate price, has virtually shattered the dream of the middle class to own a home. Moreover, any slowdown in this sector could negatively affect other sectors and adversely affect employment.
Also, the demand for consumer durables such as refrigerators, television, trucks, two wheelers and cycles, which has been largely supported by the organised financial sector, has shown stagnancy, as corroborated by leading players. This stagnancy is likely to continue and may perhaps go into a negative cycle due to high cost of borrowing.
Haven’t we seen all this in 1995. Similar situation had made the RBI increase the rates and the market came crashing down. The index for industrial production fell from 12.1% in 1995-96 to 7.1% in 1996-97, leading to fair amount of distress, particularly in the sectors of cement, steel and textiles. This caused a huge pile up of Non-Performing Assets (NPAs) in the banking system. Though of course, corporate India is better placed today in terms of raising funds through global markets and have a cushion of internal reserves, a market which is largely fuelled by consumptionled demand is likely to take a serious hit from credit squeeze and higher interest rates. Given the high consumption to GDP ratio in India, any move to dampen this may affect the economic growth momentum adversely.
Particularly, at risk are the small entrepreneurs. They have begun to flourish on the back of a high GDP growth. They are also able to leverage high manufacturing growth and rising exports. Unfortunately they would be the first ones to be deprived of much needed funds.
If this generation has to compete and succeed in this globally competitive era the cost of finance too needs to be at par with the rest of the world. Clearly, the policy is in the opposite direction. This may nip the grassroots spirit of entrepreneurship emerging in India today.
While the disease has been identified, is ‘tight credit policy’ and ‘interest rate hike’ the right prescription? Undoubtedly not!
The author (Habil Khorakiwala) is , president, Ficci
Source: Economic Times
If curbing inflation is our sole objective, we need to first understand where the price pressure is coming from. And, whether this could be controlled by reducing money supply and squeezing credit availability. A quick look at the statistics shows that the overall inflationary trend has been primarily driven by high prices in the primary sector. The growth rate of Wholesale Price Index (WPI) for primary articles in last three months (Jan, Feb, March 2007) stood at almost 10%. Is there any connection between the agricultural prices and the interest rates?
The answer is ‘No’. By hiking the interest rates we are not curtailing inflationary pressures rooted in the supply shortfall in agriculture. Rather, by reducing the lendable resources of banks, the availability of funds to farm sector will be squeezed — an area where there is a crying need for funds. The focus instead should have been on effective implementation of the programmes dedicated to the agriculture sector and the outcome of the increased outlays allocated in the budget to this sector.
A long-term action plan for the agricultural sector should be drawn up by the government to put it on a high and stable growth path. The action plan should address the issues of low farm productivity, volatility in production and poor supply chain infrastructure. The government should go full steam ahead with the structural reforms that would bolster the supply side.
Whereas, by taking such drastic monetary measures, one would fail to contain the inflationary pressures and instead, current positive growth momentum would get adversely affected. Higher interest rates would make their impact felt mostly on housing, consumer durables and automobile loans.
Housing which on one hand, is a key driver of economic growth and on the other a basic necessity of life, will be hit the hardest. Housing loan cost in past one year has gone up by almost 4 to 5 percentage points. This, combined with a sharp increase in the real estate price, has virtually shattered the dream of the middle class to own a home. Moreover, any slowdown in this sector could negatively affect other sectors and adversely affect employment.
Also, the demand for consumer durables such as refrigerators, television, trucks, two wheelers and cycles, which has been largely supported by the organised financial sector, has shown stagnancy, as corroborated by leading players. This stagnancy is likely to continue and may perhaps go into a negative cycle due to high cost of borrowing.
Haven’t we seen all this in 1995. Similar situation had made the RBI increase the rates and the market came crashing down. The index for industrial production fell from 12.1% in 1995-96 to 7.1% in 1996-97, leading to fair amount of distress, particularly in the sectors of cement, steel and textiles. This caused a huge pile up of Non-Performing Assets (NPAs) in the banking system. Though of course, corporate India is better placed today in terms of raising funds through global markets and have a cushion of internal reserves, a market which is largely fuelled by consumptionled demand is likely to take a serious hit from credit squeeze and higher interest rates. Given the high consumption to GDP ratio in India, any move to dampen this may affect the economic growth momentum adversely.
Particularly, at risk are the small entrepreneurs. They have begun to flourish on the back of a high GDP growth. They are also able to leverage high manufacturing growth and rising exports. Unfortunately they would be the first ones to be deprived of much needed funds.
If this generation has to compete and succeed in this globally competitive era the cost of finance too needs to be at par with the rest of the world. Clearly, the policy is in the opposite direction. This may nip the grassroots spirit of entrepreneurship emerging in India today.
While the disease has been identified, is ‘tight credit policy’ and ‘interest rate hike’ the right prescription? Undoubtedly not!
The author (Habil Khorakiwala) is , president, Ficci
Source: Economic Times