The three major concerns for the Reserve Bank of India and the Government are: Rising inflation, high interest rates, and increased corporate lending
Consumer prices in India went up to 5.77 per cent year-on-year in June, accelerating for the third straight month and reaching the highest since August 2014. Figures came above market expectations of 5.73 per cent due to high food cost. Inflation rate averaged at 7.67 per cent from 2012 until 2016, reaching an all-time high of 11.16 per cent in November 2013 and a record low of 3.69 per cent in July 2015. Food inflation in June stood at 7.79 per cent. Food, vegetables, pulses and sugar saw an increase in price of 12.72 per cent, 28.28 per cent and 12.98 per cent respectively. Spices went up by 8.13 per cent. Food items constitute 54.18 per cent of the consumer price index.
As the Economic Survey of 2014-2015 points out: “Recognising the need for setting up a national market, the Union Budget 2014-2015 stated that the Union Government would work closely with the State Governments to re-orient their respective Agricultural Produce Market Committee Acts, to provide for the establishment of private market yards/private markets. The Budget also announced that the State Governments would be encouraged to develop farmers' markets in town areas to enable them sell their produce directly.”
But the Agricultural Produce Marketing Committee (APMC), in practice, is not facilitating the establishment of private market/yard and is actually helping a set of farmers control or manipulate pricing of agricultural produce. Further, rice and wheat have Minimum Support Price. This is not enjoyed by vegetable, fruit and pulse producers. Therefore, their production goes down ie their supply falls and this shortage pushes up the price. Therefore, it becomes difficult to tackle food inflation which is a major concern for the Reserve Bank of India (RBI) and the Government of India.
On June 7, the RBI left its benchmark repo rate unchanged at a five-year low of 6.5 per cent. The central bank too decided to keep the cash reserve of scheduled banks unchanged at four per cent, and to continue providing liquidity as required but progressively lower the average ex ante liquidity deficit in the system from one per cent of Net Demand and Time liabilities to a position closer to neutrality.
Interest rates in India averaged at 6.71 per cent from 2000 until 2016, reaching an all-time high of 14.50 per cent in August 2000 and a record low of 4.25 per cent in April 2009. In February 2015, the Government and the central bank agreed to set a consumer inflation target of four per cent, with a band of plus or minus two percentage points from the financial year ending in March 2017.
When inflation is higher than the interest rate, then the value of one's savings decreases year-on-year. For example, if an economy has an inflation rate of seven per cent per year, and the interest rate is five per cent per year, then in real terms, the value of savings is decreasing by two per cent per year. Simply put, a negative real interest rate is a disincentive to save. Moreover, lowering interest rate reduces interest earnings from fixed deposits by retired people who largely live out of these savings made in working life.
Contrary to popular perception, retail lending is currently quite robust. In fact, growth in retail lending, carried out by banks in 2015-2016 has been the highest since 2009-2010. The so-called high interest rates on bank lending haven't had much of an impact on this front.
Gross fixed capital formation, an indicator of new capacity addition by companies, contracted 1.5 per cent in the three months to March this year, for the first time in seven years. At 26.9 per cent of gross domestic product in the January-March quarter, capital formation was the lowest (in base year 2004-2005 and 2011-2012), highlighting the muted trend in private sector investments.
Therefore, what is not moving is industrial lending. There is about one-third idle capacity in the manufacturing sector and, therefore, there is not much demand for industrial loan. Any reduction in interest rates may only help them reduce their interest burden of existing borrowings. On the other hand, this reduces the return for the banks against the same level of risk for the existing industrial loans. There is little evidence of past lending to corporate, leading to growth. It may have, instead, led to banks being saddled with bad debts and overleveraged companies with interest coverage ratios lower than one.
By the end of this fiscal, the RBI has decided to clean up the balance sheets of Indian banks which are burdened with bad loans amounting to five lakh crore rupees. So, banks have started cracking the whip on Indian companies for re-payment of loans.