Article;
RBI governor Raghuram Rajan says current policy-rate appropriately set.
Comment;
I do not know why the Industry is pressing for lower
interest rates when real interest rates are already so much down. What is real
interest rate? Nominal interest rate minus inflation is the real interest rate...
Normally investors track real interest rate to decide for investment and opt
for it when real-interest-rate is at its minimum. Actually this is precisely
the thing the Fed is trying to achieve by its monetary policy in the US. The Fed has
kept nominal interest rate at zero and is trying to push inflation up to reduce
real interest rates so that investors find it profitable to invest, lower real
interest rate will lower the cost of investment in real terms, adjusted for
inflation. But why investors in INDIA
are not recognizing the investment opportunity? Are they not cut-out for wise
investment decisions? We can not rule out the possibility that many do not know
when it is best to invest? If you do a survey many would not know what the real
interest rate is? Our investors only know interest rates compared with the
past… But there can be a difference as far as real interest rates are
concerned. In the past, it is possible, that given an interest rate a lower
rate of inflation will increase the cost of investment because real interest
rate (nominal interest rate minus inflation) will be high but now when
inflation is high and real interest rate is near zero then it is more
profitable to invest in economic activity. We know inflation reduces the cost
of debt…Inflation lowers the cost of debt, because it lowers real interest
rates… I think the Industry should recognize this opportunity and does not
press the RBI for rate cut. Moreover, a lower real-rate-of interest will
attract fewer bank deposits. And, the industry while pressing for rate cuts is
also reducing interest rate on its savings and less capital will be invested,
wages are consumed and profits are invested. If industry will wait for rate
cuts and lower inflation it means they are waiting for real interest-rates to
go-up because inflation will go down. Rate of inflation is also a sign of
demand in the economy, environment for investment is good, what the industry
will produce will be consumed by the economy, but we should not indulge in
overproduction because that would push the economy in deflation and would
necessitate changes in policy…
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