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CEA Questions RBI’s Monetary Policy Stance, Says Rates Too High

Thursday, June 18, 2015
By A Business Reporter

Making a strong case for reduction of policy rates by the Reserve Bank, Chief Economic Advisor Arvind Subramanian has said the real interest rates are "whoppingly" very high and have made it difficult for corporate to deal with the problem of high debt. "So, is the stance of current (monetary) policy appropriate? Of course, that is difficult to say but at the very least, there needs to be more analytical discussion. In particular, there needs to be greater recognition that these are unusual times.

"Real policy rates have diverged significantly for consumers and producers, and are unusually high for the latter. For producers, high real rates must also be seen against their balance sheet problems," he said in an article in VOX CEPR's Policy Portal. Reserve Bank under present Governor Raghuram Rajan took into account the inflation based on Consumer Price Index (CPI) and primarily focused on keep price rise under check.

The RBI, however, has reduced the policy interest rate by a total of 0.75% in three tranches since January. The repo rate at present is 7.25%.

The real interest, which is policy rate minus inflation, varies widely after taking into account price rise based on CPI and GDP deflator. "Today, real policy rates are either 2.4% based on the CPI, 5.9% based on the average of the CPI and WPI, or a whopping 7.5% based on the GDP deflator. Which is the right measure of the monetary policy stance?," he questioned. In normal times it would be completely unobjectionable to focus on CPI, he said, adding these are not normal times as price indicators were pointing dramatically different directions.

Subramanian further said that high interest rates would make the task of corporate in improving their stressed balance sheets even more difficult. "Resolving the stressed balance sheet problem – which is currently a serious impediment to the revival of private investment – at high real interest rates becomes even more difficult," he wrote. Low demand in domestic and international markets coupled with high interest rate have adversely impacted the profitability of the corporate. Subdued growth also pushed up the bad loans of the banking sector and companies are finding it difficult to restructure loan portfolio in view of the high interest rate.

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