RBI policy: Here is why the central bank needs to stop raising rates

RBI, following conventional wisdom, is guilty of wanting to show that it's doing something to bring down inflation while perhaps helping worsen it by slowing down efforts to increase capacity, output

What should be the context in which the fiscal and monetary policies 2023-24 are framed? I mean, the overall global context, not just the forthcoming General Election of April-May 2024?

Should the fiscal policy be expansionary? Should interest rates be lowered? Let’s try and figure this out.

The governor of the Reserve Bank of India (RBI) has rightly cautioned Indian banks from lending to the world and especially to the West, where interest rates are rising, adversely affecting the ability of borrowers to repay the loans. He couched his warning by talking about global spillovers.

More recently, Nouriel Roubini, an American economist and a guru, has sounded an even more dire warning in an article, which he ends by saying, “The mother of all stagflationary debt crises can be postponed, not avoided.”  

“Just look at explicit debts. The figures are staggering. Globally, total private- and public-sector debt as a share of GDP rose from 200 per cent in 1999 to 350 per cent in 2021. The ratio is now 420 per cent across advanced economies and 330 per cent in China. It is 420 per cent in the United States, which is higher than during the Great Depression and after World War II.”

The Indian debt-to-GDP ratio is nowhere near this. It is around 85 per cent. The government should be hooping with joy.

According to Roubini, as soon as “central banks abandon the fight in the face of the looming economic and financial crash, nominal and real borrowing costs will surge.” Pop goes the weasel.

Even as we quake in our shoes at the prospect of a major and long-lasting global economic depression, we must be thankful for one thing: complete certainty has replaced uncertainty. We now know for sure that a huge global earthquake is coming.

Whether it is 6.8 on the Richter scale or 7.1 is entirely irrelevant. The damage will be widespread. India will not escape it. But if we manage the economy sensibly, the damage could be relatively light.

Hence the question: how should India deal with it? It starts with an advantage. Its debt as a percentage of GDP is only about 85 per cent, which is wholly manageable.

Indeed, if this debt level is not underestimated, India will have a lot of headroom. It can actually increase the debt level.

But how? Should the increase come from the government or non-government sources?

In my view, this is the question that the Budget must address. But it isn’t an easy problem to solve because, ultimately, the repayment capacity must determine the answer.

Luckily household debt in India, at least in the formal sector, isn’t unmanageably large. Neither is corporate debt at 50 per cent. That leaves government debt, which, too, is ok.

That’s why the answer to the question about the Budget is staring us in the face: the banks must improve their lending. Fortunately, their balance sheets are once again healthy, and they can increase their lending.

And this brings up the RBI’s persistent increases in interest rates. Is it overdoing it by assuming demand-pull inflation, whereas it is cost-push inflation?

I think the RBI, following conventional wisdom, is guilty of wanting to show that it’s doing something to bring down inflation while perhaps helping worsen it by slowing down efforts to increase capacity and output. Hence the need to stop raising rates.

The next meeting of the monetary policy committee is in February, just after the Budget is presented on the first of that month. That’s the time to stop raising rates — if not actually reducing them.