With bond markets seemingly calmer after the announcement of the government?s borrowing programme for this fiscal and some monetisation of debt expected to ease pressure further, the attention should come back for now to monetary policy. That?s another way of asking what will happen to lending rates? HDFC is the latest major bank to drop its prime lending rate. But all the rate reductions over the past months have been weak price signals because credit off-take has weakened. What doesn?t enter this debate as frequently as it should is that if one takes seasonally adjusted inflation into account?that?s the way to look at data?India?s real interest rates are monstrously high. This is absurd when everyone and their uncle knows the economy is going through a downturn. The rate of growth of GDP has dropped by more than 200 basis points, but real interest rates are far higher than they were during boom times?how can we call this state of affairs normal or a reflection of how mature our monetary policy is? It is a reflection of how badly the signalling system works from the central bank to the real economy.
If the system is running a loose fiscal policy to revive the economy, it makes little sense to run a monetary policy that doesn?t produce low interest rates. First, the absence of low rates affects the government?s debt obligation. Second, it contradicts the fiscal pump priming?s main goal?of spurring demand. This argument stands even if bond markets keep their nerve through this fiscal on the matter of government borrowing and the banking system funds the government relatively easily. Even if the government doesn?t crowd out private borrowers, the price of credit will. And more of this may come. With food inflation persisting and with uneven monsoon engendering inflationary expectations for primary commodities, monetary policy may be used again as a blunt instrument. India has already paid for this once?supply-side food price inflation resulted in tight money policy that depressed growth even before the financial crisis and the global slowdown. If it happens again later this fiscal, growth prospects may be affected at a most critical juncture. Imports should be used to moderate food prices and another sharp cut in RBI?s policy rates?repo can and should go down by another 100 basis points?should be tried to lower lending rates.
