Stop obsessing about the rate cut

The economic policy discourse in developing countries is driven by two types of illusions. One, that stock market performance is indicative of economic fundamentals and the other, that independent monetary policy is not supportive of economic growth. The reality is more complex.

Over the past six years, the developed world has been battling to lift economic growth with the help of lower interest rates, but without much success, leading to the growing concern that stimulus programmes might have helped the stock markets more than the real economy.

Even Christine Lagarde, managing director of IMF, was worried about “too little of economic risk taking and too much of financial risk taking” from the prolonged stimulus programmes.

Speaking at Georgetown University in October 2014, she said, “There is concern that financial sector excesses may be building up, especially in advanced economies. Asset valuations are at an all-time high.

A further worry is the migration of new market and liquidity risks to the ‘shadows’ of the financial world”.

For a bank based economy like India, interest rates are the key to spur and support growth. However, leaning only on interest rates to push growth amounts to going a bit too far.

Sparring with the central bank, which has a proven record in assessing the conditions that warrant a rate cut, is rather unwarranted. What else can we do?

The biggest advantage India currently has is the sharp fall in commodity prices. Between 2012 and 2014, indices (published by IMF, 2005=100) of metals fell from 191 to 156; industrial inputs from 167 to 147; energy from 195 to 145; and non-fuel commodities from 171 to 154.

During 2014, commodity prices fell across fuel and non-fuel categories. Apart from oil prices, which fell by 47 per cent in 2014, the price of natural gas fell by 48 per cent, copper by 16 per cent, gold by 15 per cent, silver by 28 per cent, wheat by 14 per cent and sugar by 16 per cent.

Of course, these prices wont stay there for long and it is important to seize this opportunity through proactive policies that will help stimulate higher production and productivity.

According to the Unctad Global Investment Report, 2014, global FDI flows are about $1.6 trillion in 2014, which could go up to $1.7 trillion in 2015 and $1.8 trillion in 2016.

Developing countries accounted for the largest share in the global FDI in 2014 to the tune of $778 billion (54 per cent).

Of this, Asia accounted for 54 per cent of the FDI inflows at $426 billion of which more than 80 per cent went to east and south-east Asia ($347 billion.)

South Asia got a meagre $36 billion in FDI, which is just 8 per cent of what Asia received, 4.6 per cent of the developing countries and 2.4 per cent of the global FDI and much lesser than what Latin America ($292 billion) and Africa ($57 billion) received.

Given the fact the FDI flows in India were just $24 billion in 2012 and $28 billion in 2013, (comparisons: China $124 billion, Russia $79 billion, Brazil $64 billion and Mexico $38 billion in 2013) creating conditions that attract a larger size of foreign investment flows is an important priority.

For India, the only consolation is that it is among the top 20 countries in regard to inward FDI flows. To make ‘Make in India’ work this is an area that needs most attention and thrust.

New capital raised in the form of initial public offerings in the global public capital markets amounted to $256 billion in 2014, which is 50 per cent higher than the previous year’s and the best since 2010. According to consultancy firm EY, 47 per cent of the new capital raised in IPOs in 2014 was from rapid growth markets. US stock exchanges accounted for largest share of the new capital raised (37 per cent) followed by Asia Pacific (32 per cent) and the Europe (24 per cent).

While India stands at sixth in terms of deal volume with 44 issues (USA 224; China 206 issues), it is nowhere in respect of deal value with funds raised to the tune of a mere $263 million as compared to $30 billion of new capital raised in Hong Kong, $16 billion in Australia, $10.5 billion in Tokyo, $5.8 billion in Shenzhen and $5.2 billion in Shanghai.

For a country keen to chart an aggressive development agenda, it is not just bank loans that make it possible. Strong primary capital markets are critical for resource raising, which India severely lacks, and it is where policy could be more proactive.

The International Organisation of Securities Commissions (IOSCO) reiterates the importance of corporate bond markets as an important alternative source of domestic debt finance. The size of the emerging markets bonds which was $2.3 trillion in 2000, mostly comprising sovereign bonds, rose to $16 trillion by 2013, with shares of sovereign and corporate bonds turning more or less equal.

A recent study by the RBI observed, “While India boasts of a world-class equity market, its bond market is still relatively underdeveloped and is dominated by the Government bond market. The share of outstanding Government bonds in India were 39.5 per cent of Gross Domestic Product as of 2010 and compares favourably with other Asian countries such as China (27.6 per cent) and South Korea (47.2 per cent).

The share of corporate bond outstandings in India, however, was only 1.6 per cent of GDP in 2010 compared to Malaysia (27 per cent) and South Korea (37.8 per cent) in the comparable period.”

It is important that government moves ahead of its excessive engagement with just lower interest rates to trigger economic growth and expand the policy reach into other initiatives too.

The writer is former chief economist of the Indian Banks Association. The views are personal