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Mild slowdown at next turn

Mild slowdown at next turn
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First Published: Thu, Jun 26 2008. 12 36 AM IST

Illustration: Jayachandran / Mint
Illustration: Jayachandran / Mint
Updated: Thu, Jun 26 2008. 12 36 AM IST
The Reserve Bank of India’s (RBI) quick and sharp moves to increase the cost of money should leave us in no doubt about where interest rates are headed in the months ahead. One question is now on top of many minds: Will higher interest rates torpedo economic growth?
Illustration: Jayachandran / Mint
A small detour into history can be useful. The lessons from a previous episode of high growth and monetary tightening more than 10 years ago suggest that the growth rate of the economy could halve if money gets very expensive. But that seems an improbable possibility right now. Growth is likely to dip a bit; it is unlikely to collapse, unless the world economy tips over into recession.
It is perhaps time to take a closer look at what happened in the mid-1990s. The situation was similar to the one we have today. An economic boom had sparked off double-digit inflation. The country was heading towards the 1996 general election and a concerned Narasimha Rao allowed his finance minister Manmohan Singh and RBI governor C. Rangarajan to increase interest rates to quell the inflation fire.
They succeeded dramatically — though it sent the economy into a tailspin. Critics of that policy insist that the central bank moved too aggressively and set the economy back by many years. The other side says that the slowdown in the Indian economy after 1997 was also due to the fact that world demand had slumped after the Asian crisis. It is unfair to blame monetary policy for what happened.
Look at the numbers. The rates at which banks lent to their best customers in the middle of the last decade were at least 6% higher than the average inflation rate of those years. In comparison, right now, lending rates are a bit below the inflation rate. By this measure, RBI still has a long way to go before the interest rate cycle peaks.
We doubt Y.V. Reddy will push up interest rates to the heights they reached in the mid-1990s, unless inflation keeps climbing and there is a run on the rupee. And what about growth? It almost halved — from 8% in 1996-97 to 4.3% in 1997-98. The slowdown is likely to be less serious this time around. Unless there is a global recession, India will have lower growth over the next two years, but a halving of the growth rate seems unlikely.
In other words, what we see in the rear-view mirror may be a bit too dark; what we see ahead is a less bleak scene.
Will higher interest rates torpedo economic growth? Write to us at views@livemint.com
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First Published: Thu, Jun 26 2008. 12 36 AM IST