Will Interest Rate Cut Work?

The 1.5 per cent cut in the small savings deposits like national savings certificates, public provident funds and all other post office schemes in this year’s budget is not surprising in the light of what the Economic Survey had to say on the issue a week before the budget. In its overall survey of the economy, the Survey concluded that “sustained economic growth would require a significant improvement in investment, which in turn would depend on (amongst other things), structural reduction in inflationary expectations and real interest rates...” Elsewhere, the Survey stresses the “...importance of lower real interest rates in accelerating industrial growth and boosting India’s competitiveness abroad...”

There is no doubt therefore that what is expected of the interest rate cut is a boost to investment. This suggests a shift towards monetary policy in reviving an economic downturn, as in advanced economies like the US and Germany. In principle, there is nothing wrong in the use of monetary policy rather than fiscal policy, as the former has shorter lags. The question however is whether the link between investment and interest rates is as tight in India. The second point is the fast disappearing role of public investment as a tool to spur private investment.