The Telegraph
Since 1st March, 1999
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- Globalization gives birth to copycat economics

Intense flutter in establishment dovecotes, the inflation rate has exceeded 8 per cent per annum, it threatens to scale even higher levels, something needs to be done. The greater worry is over the impact of rising prices on the forthcoming assembly elections in Maharashtra and elsewhere. People are so unreasonable, they get angry when prices rise and tend to vote against those in power; a few measures must be taken to salvage the situation. Not surprisingly, the issue of cheap money policy has once more come to the fore; perhaps a review is called for.

The problem has not emerged overnight. Ever since a deliberate decision was taken to bring down interest rates, the average bank deposit rate has lagged behind the rate of inflation. This has resulted in a continuous erosion in the real worth of whatever savings the majority of the nation are able or inclined to chalk up. Pensioners and other constituents of the middle class, along with fixed-income earners and wage workers who too have been hard hit, have registered their protest. Till recently, the authorities were not overly concerned. But, with prices sharply shooting up, there are now signs of an intensified awkwardness. Whatever the assurances held out by ministers and their minions, a further rise in prices seems inevitable: as long as the Americans are determined to stick it out in Iraq. The turmoil in the international oil market is unlikely to abate. The consequences are going to be grim for heavily oil-importing countries such as India. Should the dogma of low deposit interest rates persist, domestic difficulties could only aggravate.

For policy-makers, the dilemma is real. Low deposit rates make for low lending rates, which, it was till now assumed, stimulate investment. Capital formation has been sluggish in the Indian economy in recent times. It has been so in the United States of America too. But there is a difference. Technological progress has been so rapid in the US that existing capital stock is more than adequate to produce the goods and services the nation needs. In fact, demand satiety in that country has led to the phenomenon of plants and factories scaling down activity from five days to four days in the week; in some instances factories hitherto working for four days have switched over to a three-day work schedule; workers have been asked to stay at home in the remaining days, with their emoluments fully protected.

In this kind of uncertainty, entrepreneurs naturally shy away from fresh capital investment. This however creates a crisis in the labour market; the roll of the unemployed lengthens. To quieten social discontent, fresh investment has to be coaxed into the economy. Monetary policy has been put to use for the purpose. The advice has gone out: lower and lower further the interest rate for bank lending, thereby inducing entrepreneurs to borrow more and expand their operations. Billions and billions of surplus funds are lying idle with the banking system; the US administration has been keen to put such funds to work through the mechanism of a cheap money policy.

Globalization, off and on also known as neo-colonialism, gives birth to copycat economics. Since the Americans have lowered interest rates, for dear life we too must also do so in India: such was the decision taken at the highest level half a dozen years ago or thereabouts. Bank deposit rates were slashed from 10 per cent and above to around 5 per cent. Identical situations, even if in different countries, it was maintained, necessitate identical treatment. Industrial recession haunts the US, it haunts India as well. Therefore, so went the prescription, follow the leader: to encourage investment and growth, force down interest rates in our country too in the manner it has been done in the US.

A basic flaw vitiates the argument though. In the US, there is no dearth of savings, the per capita income is in the neighbourhood of $30,000 or more per annum, the banks are awash with savings; the problem is to find outlet for such savings. In India, in contrast, given the pervasive poverty, savings are low. By bringing down interest rates, savings are not stimulated, but discouraged, thereby affecting investment. Low lending rates fail to give a boost to capital expansion for yet another reason: the lack of purchasing power of the nation's overwhelming majority keeps the demand function depressed. Entrepreneurs are no fools. Low interest rates do not induce them to expand their activities; the prospect of a healthy rate of return from new investments is, they know, circumscribed by the size of the market.

But perhaps there is more to it than meets the eye. In a class-riven society, the monetary establishment too panders to upper class dreams. Low interest rates are accordingly intended to serve another objective as well. A citizen with some savings at his disposal has the option of placing these savings either as deposit with the banks or for share market speculation. The economic history of several countries actually suggests an inverse relationship between economic growth and speculative gains; speculative activity takes a backseat when production surges forward on the wings of fresh capital formation sustained by rising bank deposits. Speculation, on the other hand, emerges as king when production slumps.

Pushing by fiat the interest rate down so that it falls below the rate of inflation may therefore be an excellent stratagem to advance the cause of favoured groups. Faced by the prospect of shrinking income and earnings, desperate citizens may choose to play Russian roulette in the share market; the banks in any case offer a piffle. Whatever the befuddled ordinary citizens lose in the bourses would line the pockets of the fat cats. The lobby favouring cheap money could, in the circumstances, continue to rule the roost.

Unless, of course, a shift in monetary theology takes place at the sanctum sanctorum itself. Reports are filtering in that precisely such a shift is taking place. While industrial recession persists, the American economy is nonetheless coming under increasing pressure, in the sense that prices of sensitive goods are going up inordinately. What was unthinkable till yesterday has therefore been permitted to enter the list of thinkables: monetary experts in the US have begun to urge a tightening of money supply to cool the economy; the bank rate is about to be raised. Therein lies subaltern hopes. Once the Federal Reserve System in the US raises interest rates, the Reserve Bank of India too is bound to spring to action and order the banks to raise deposit rates appreciably. As precursor, the cash-reserve ratio has already been raised.

What the authorities will do with lending rates is a different matter though. True, dear money policy may be defended on the classical ground that it weeds out the inefficient from the market. Affluent categories could, however, continue to obtain money from the banks at favoured rates because they supposedly served this or that national cause, such as export promotion, or promotion of tourism, and of course the sacred arena of information technology. The poor and the disadvantaged sections however are likely to continue to receive the short shrift, with the lending rate pitched high for them. This was necessary, it would be said, to cover the 'risk factor'; providing finance to the impoverished classes, who does not know, is a risky venture. The truth is somewhat to the contrary; it is a claque of industrial and commercial tycoons who have till now failed to return an amount aggregating to as much as Rs 200,000 crore they had borrowed from the commercial banks. They are bound to be treated with kid gloves while the poor are shown the door. This is high finance ordinary mortals are not expected to understand.

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