One popular perception of the RBI’s cut in CRR by 25 basis points and its reluctance to do what the markets expected is that it is at odds with the Finance Ministry.
The Finance Minister himself was reported as being upset; he also appeared churlish when he suggested that growth was as important as inflation. Surely, the RBI would not deny that; it never has. But it has a mandate and limited instruments with which to fulfil its obligations.
In an interview to this paper, D Subbarao, when asked if the status quo on interest rates would not hurt the common man, simply and correctly identified low and stable inflation as a better condition for the common man. Interest rates do not affect the “common man” as much as inflation as any housewife will tell you. But it’s also clear that the RBI has to do something for growth, and there lies the problem.
Inflation vs growth
From the RBI’s calculated measures to balance what is clearly turning to be two irreconcilable objectives it seems destined to be cast as spoilsport; high interest rates have been identified a big villain because it is the socially most visible target of frustration felt by both policy planners and some stakeholders gnashing their teeth at declining GDP growth.To make matters worse, the RBI has played it both ways; it has cut CRR somewhat but it has also raised provisioning norms.
By doing so it is fulfilling its other mandate in the best way it can: maintain the health of banks.
Health of banks
There’s some reason to be concerned there. Indian banks’ portfolio of stressed assets in steadily increasing. The RBI finds this disturbing and so should it be: at the end of March non-performing assets stood at 2.9 per cent of gross assets, climbing to 3.25 per cent in June.
Part One of the Annual Report of the Reserve Bank of India says: “ Restructuring increased substantially during Q4 of 2011-12, taking the restructured loans at the end of 2011-12 to about 5 per cent of the loan book of the scheduled commercial banks (SCBs), up from 3.9 per cent a year ago.”
Low interest rates for growth?
When North Block and other key policy planners and industry representatives say the RBI should cut interest rates to boost the economy, what exactly do they mean?
Low interest rates do not automatically trigger growth as Ben Bernanke is discovering in America; D Subbarao’s predecessor, Y.V. Reddy consistently raised interest rates after 2006 on fears of runaway inflation, but two years of high GDP growth followed.
He was lucky and so was India that the world spun into recession after 2008 and thus took the sting out of a potential speculative boom. The collapse of Lehmann Brothers could not have been more timely.
GDP Composition
But why was the economy overheated? Or why did the RBI fear it was? Was there something in the structural shifts in the organised economy, the compositional variations over the decades in GDP that determined not just the pace of its expansion but its vulnerabilities too?
The current Economic Survey (2011-12) gives us some clues. Presenting sixty year data spanning the period of India’s post-Independence, on the relative shares of the three sectors, agriculture industry and Services in GDP, the Survey shows that the farm sector has always held up the rear: The long-term growth of agriculture, over sixty years was rather dismal — till 1980-81 it was 2.1 per cent and 3.1 per cent thereafter, recording a sixty year an average of 2.1 per cent. It is significant that industry grew faster than services till 1980-81, after which it took second place.
Services expanded from 30 per cent to 38 per cent of GDP by 1980-81 and grew rapidly for ten years till 1990-91 after which it became the mainstay of the GDP — with an expansion rate of 56 per cent.
What was driving services? “Trade hotels, restaurants” with 16.9 per cent and followed by financing, insurance and real-estate with 16.4 per cent. Together with construction at 8 per cent and “Community and personal services” (14 per cent) these contributed nearly half to the size of the GDP.
It is not surprising that credit too flows largely to these interest-sensitive sectors, a fact that the central bank has been worrying about for years.
Services and Jobs?
What is wrong with such a dramatic shift? In fact it might even explain why we are what we are: an emerging economy on the cusp of advanced-nation status. Right?
Not so. One way might be to consider how much this shift contributed to the growth of jobs. A report on Global Employment Trends 2012 by the International Labour Organisation (ILO) says: “The robust growth witnessed in the region (South Asia), driven largely by India, has been mostly associated with a rapid rise in labour productivity rather than an expansion in employment.”
Here’s the interesting part. Up until the end of the millennium, that is just a year before the balance of payments crisis and the onset of India’s liberalisation, “employment and labour productivity grew at similar rates.”
Since 1991, “…increased labour productivity took over as the driver of growth in the region. Between 2007 and 2011, labour productivity increased by 6.4 per cent on average, while employment expanded by just 1.0 per cent. This situation is prominent in India, where total employment grew by only 0.1 per cent over the five years to 2009/10 (emphasis added).”
Interest rate cuts anyone?
The fears of overheating flow from the composition of an economy riven from a sector with the highest potential for sustainable growth and driven by one with the most fragile and speculative base with high productivity yes, but low employment potential.
Most policy changes, in the pipeline or contemplated, cater to this section of the organised economy, the “major and vital force” as the Economic Survey gushes that will propel India.
Perhaps it will: but it would leave most Indians behind.