In his first media appearance after taking over as finance minister, Palaniappan Chidambaram made a startling comment about interest rates that makes one doubt his credentials as a reformer.
Chidambaram said: “Interest rates inhibit the investor and are a burden on every class of borrowers. Sometimes, it is necessary to take carefully calibrated risks in order to stimulate investment and to ease the burden on consumers. We will take appropriate steps in this regard,” he said.
Let’s take each sentence of phrase separately to bring out its significance and inappropriateness in the current context.
Interest rates inhibit the investor and are a burden on every class of borrowers, he says.
True, interest rates are a cost to any borrower at any time. But interest is always a relative cost. Even a 1-2 percent interest rate can be a burden (as in America now) when growth is slow and lethargic. Even a 10 percent interest rate is not too much when the economy is booming (as was the case in 2003-08).
This is clear from recent Indian experience itself. Currently, the Reserve Bank’s repo rate (the rate at which it lends to banks) is 8 percent and the GDP growth rate has been decelerating from over 8 percent a couple of years ago to possibly 6.5 percent this year (or even lower).
From this we can conclude that 8 percent is too high to support a recovery. However, consider what was the rate in 2008, when Chidambaram was finance minister too. We had a repo rate rising to 9 percent in July 2008, and the economy was growing like gangbusters till then. It needed a Lehman crisis to bring down growth. It wasn’t the interest rate that brought down growth.
The repo was being raised then because inflation was soaring out of control, both in terms of wholesale and consumer prices, both heading for or already in double-digits.
This is the case today, too. The consumer price index is clearly in double-digits, and wholesale prices are over 7 percent – and possibly set to rise further.
The difference: in 2008, growth was still accelerating; in 2012, growth is decelerating. However, the real difference is in the fiscal mess the UPA has created in the interregnum. In 2007-2008, the last full year in which Chidambaram was finance minister, the government’s fiscal deficit was Rs 1,26,912 crore. In 2012-13, the budgeted fiscal deficit is Rs 5,13,590 crore – four times as much – and it could get worse.
So, clearly the government’s voracious appetite for money is skewing interest rates and skewering borrowers. The government is eating their lunch. It is not high interest rates per se that bothers India Inc, but the lack of growth, policy paralysis and the government’s own appetite for borrowing that is the problem. The only “class of borrower” Chidambaram is really worried about is the government.
The moral: Chidambaram should borrow less so that other, more deserving, classes of borrowers can benefit.
Sometimes, it is necessary to take carefully calibrated risks in order to stimulate investment and to ease the burden on consumers. Or so says Chidambaram.
One wonders what is so “carefully calibrated” about a curt order to the Reserve Bank Governor to cut interest rates ASAP. What is the metric or scale against which Chidambaram is going to carry out this calibration? Will the rate be measured against how fast inflation is lowered, or the fiscal deficit, or will rates only be brought down because GDP is sliding?
It is clear that Chidambaram’s brief is to revive growth and what the PM called “animal spirits” in the economy. But the FM is baring his fangs only to the RBI. He is purring like a cat to foreign investors, as evidenced in the announcement on reviewing the retrospective tax.
The calibration, if it were sensible, should happen something like this: reduce diesel subsidies by X amount, and cut interest rates by Y percent to compensate for the growth-depressing rise in energy prices. But we haven’t seen any action on this front. But this is the kind of calculated risk that is sustainable.
But the most important element in Chidambaram statement is what is implied in it – and what he has left out. He gets hot under the collar about the tribulations of every class of borrowers, but he has no empathy for the real people who enable growth: savers.
He could equally have said: Low interest rates at a time of high inflation act like a tax on every class of saver. We will thus focus on lowering inflation to enable us to cut rates.
Chidambaram said he wants to raise the savings rate from 32 percent to 36 percent, but how is he going to do that by cutting interest rates?
Already, double-digit inflation is giving savers negative returns. Cutting rates well ahead of inflation means he plans to damage savers even more.
Mr Chidambaram, you should remember that in any economy there will always be more savers than borrowers. We all borrow five or 10 times in a lifetime, whether it is for a car or a house, but we save every month of our working lives – whether it is through compulsory provident fund deductions or through bank fixed deposits or investments in shares and mutual funds.
Moreover, there is a good reason to shed less tears for corporate borrowers. Here's why. When wholesale inflation is at 7.25 percent, and a company borrows at, say, 11 percent, it is effectively paying only a 3.75 percent real rate (rate minus inflation). But even this is not correct. Companies can expense interest costs in their balance-sheets, and so at the top tax rate, the effective post-tax rate is really around 2.5 percent. Hardly a good reason for India Inc to cry on Chidambaram's shoulders.
So, Dear FM, don’t screw savers in the process of easing the already light post-inflation interest burden on borrowers.