Economic Survey: Need modest real interest rates to boost pvt investment

The Economic Survey for 2018-19 stressed the need to lower real interest rates to give a boost to private investment, something that was proposed by a member in the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC).

The real interest rate is the difference between the lending rate (the Survey took State Bank of India’s base rate) and the prevailing inflation rate. Similarly, the real policy rate is the repo rate minus inflation. 

Considering the latest inflation print at 3.4 per cent, while the repo rate is 5.75 per cent, and the SBI base rate is 9.05 per cent, the real policy rate works out to 2.35 per cent, while the real interest rate is roughly 5.65 per cent.

Both the real interest rate and the real policy rate are way above India’s competitors. The Economic Survey made a strong pitch to bring them down.

There are various views on what an ideal real policy rate for India should be. The consensus seems to be 1.5-2 per cent. 

This means at the current inflation rate, which is expected to remain till December at least, the repo rate has the scope to go down by another 35 basis points. 

The Economic Survey noted that the real rate of interest had “increased significantly in India over the years”. 

However, with the bankruptcy code in place and capital infusion done in banks, the twin balance sheet problem is getting addressed.

“Now that the foundations for expansion have been laid, it is time to significantly lower the cost of capital,” the Survey said.

According to Chief Economic Advisor Krishnamurthy Subramanian, savings are driven primarily by demographics and income growth. 

Therefore, keeping domestic interest rates high may not encourage savings behaviour. Rather, a “mildly positive real rate is good enough”, he said.

This savings behaviour also gives a key degree of freedom to policymakers as the savers and the borrowers can be disentangled. 

“As investment depends crucially on a low cost of capital, reducing real interest rates need not necessarily lower savings when the demographics are favourable. At the same time, the reduction in real interest rates can foster investment and thereby set in motion the virtuous cycle of investment, growth, exports and jobs,” the Survey said.

The Survey will have powerful backers even in the RBI, particularly as the generally hawkish Deputy Governor Viral Acharya is slated to leave the central bank. Shaktikanta Das, who became RBI governor in December, has reduced interest rates thrice since February. 

His dovish colleague in the MPC, external member Ravindra Dholakia, is a strong proponent of rate cuts. 

“In my opinion, we should continue correcting our real interest rates by bringing down our policy rate,” Dholakia said in the MPC minutes, advocating a 25-basis-point cut even as he preferred a 40-basis-point cut in the policy repo rate.

“Our real policy rate is in excess of 2 per cent and our real interest rates are very high, making our production globally less competitive. We must bring it down to realistic levels of around 1.5 per cent sooner than later,” Dholakia had said.