Mr Jaitley, the answer to slowdown does not lie with Raghuram Rajan

The demand for an interest rate cut by the Reserve Bank of India (RBI) has slowly been rising to a crescendo, with India Inc and even the Finance Minister raising a din over it. Arun Jaitley lent his considerable weight to the idea in a recent interview: “Currently, interest rates are a disincentive. Now that inflation seems to be stabilising somewhat, the time seems to have come to moderate interest rates.”

In his December policy, RBI Governor Raghuram Rajan may relent, considering that his is the lone voice seeking to keep rates higher. However, if anyone thinks a cut is going to deliver some kind of investment bounce, forget it. The evidence is strongly against the idea that rates cuts inevitably boost investment. Investments are boosted more by returns (or the prospect of returns) than by the cost of funds.

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A recent Crisil Insight study gives us a clear idea about why this is so.

Contrary to what finance ministers and India Inc may believe, real interest rates in India have largely been benign for most of the last decade. Comparing two periods under the UPA when investment boomed despite higher interest rates and vice-versa, the study notes: “Investment growth, particularly private corporate investment, plummeted in the fiscals 2013 and 2014, despite low real interest rates. During this time, the policy rate in real terms - repo rate minus retail inflation - has been negative, and real lending rates averaged 2.4 percent. This is significantly lower than the 7.4 percent seen in the pre-crisis years (2004-2008). Yet investment growth dropped to 0.3 percent, down from an average 16.2 percent seen in the pre-crisis years.”

This means if investments are not recovering, the blame cannot be laid at Rajan’s door. Or, for that matter, at his predecessor Duvvuri Subbarao’s.

The answer to the problem of low investment must therefore be sought elsewhere - and low returns on investment may be a bigger villain. Business will invest if the returns are greater than the cost of borrowing - at the very least. The Crisil study says that real returns on non-financial corporate investments - as seen from corporate return on assets - “fell sharply to 2.8 percent in fiscal 2013 and 2014 from nearly 6 percent in the pre-global financial crisis years. If the return on investments already made has fallen so sharply, expected return on investments planned but not yet made would have plummeted even more, rendering them unfeasible.”

And remember, the years from 2010 onwards saw the beginning of policy paralysis, thanks to the emergence of scam after scam from the UPA’s cupboard, from Commonwealth Games to 2G scam to Coalgate. That, coupled with environmental tangles over mining projects, effectively made investments fairly unattractive in the short term.

And let’s not forget, 2G licences were cancelled, and in September, coal blocks allocated after 1994 were also cancelled. Both these decisions will not only singe the telecom and coal industries, but the banking industry as well. Never mind the level of interest rates, banks will not be in a rush to lend or corporate to borrow.

The Crisil report also looked at the case of the automobile industry, where despite the fall in real interest rates demand was down, especially in the rate-sensitive small car and commercial vehicles segments. The study says that “real lending rates have fallen during the past two years due to persistently high inflation. Despite lower real lending rates which favour borrowers, there is a sharp slowdown in both, loan disbursals and sales growth, especially after fiscal 2012. The decline is especially pronounced in the commercial vehicles segment and is most likely due to factors such as stalling of infrastructure projects, general slowdown in industry and a ban on mining activities that affected demand. Similarly, sluggish income prospects are likely to have impacted the demand for cars and utility vehicles, albeit to a lesser extent.”

The only conclusion possible is that rate cuts are not a silver bullet for the problems of low investment and low growth. Jaitley should stop making Rajan a scapegoat for his problems, when the solutions lie elsewhere.