ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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The Interest Rate Affair

There is forever a demand to reduce interest rates, but the evidence in India in recent years is that lower rates by themselves do not spur investments. The rate of investment depends on other factors. What an interest rate cut does is directly increase the profi ts of the corporate sector.

The post-Union Budget 2015–16 scenario is witnessing the emergence of a possible conflict between the central government and the Reserve Bank of India (RBI) regarding the formation of a monetary policy committee. The apparent intention is to make decision-making on interest rates more democratic.

Like many other areas, such democratisation might imply politics through the backdoor, undermining the independence of the RBI, in particular that of the RBI governor. This is the impression we get from the news media and to some extent it matches with the theoretical and practical perception of Indian policymaking. Whether it is politics or a movement away from an unnecessarily excessive hawkish stance of the RBI is a wild guess we have to make. But the obsession of corporate India and SENSEX-loving governments with a cut in the interest rate has been in vogue for quite some time since the central bank was entrusted with a relatively independent role in monetary policymaking. Hence, it is important to emphasise what lower interest rates can and cannot achieve, in general, and in India, in particular. These are classroom economics arguments. But most of the well-known commentators on Indian economic policies are not teachers, and as vested interests prefer sloppy arguments and as the news media tends to hide facts that cannot be sold, it becomes worthwhile to revisit a few related core arguments from time to time.

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