<div><em><strong>Sutanu Guru</strong> argues how the lowest inflation rate in a decade must lead to lower interest rates</em></div><div> </div><div>Wholesale inflation based on the Wholesale Price Index (WPI) has plummeted to a 10 year low of – 4.1 per cent for the month of July. This, after the consumer price inflation too falling to an almost record low of 3.7 per cent in the previous month. In comparison to a negative 4.1 per cent, wholesale inflation stood at 5.4 per cent in July 2014. People, that category includes so called pundits and intellectuals will argue that the numbers are hogwash and point out to rising prices of onion, milk and pulses to claim inflation is not coming down. They will insist that the RBI Governor Raghuram Rajan is doing the right thing by not cutting interest rates. </div><div> </div><div>But the fact is; numbers don’t lie. They don’t even mislead. It is now a year since inflationary pressures have eased in the Indian economy. And there really is no excuse left anymore for Rajan and the RBI to not cut interest rates anymore. Prior to August 4 this year, realists as compared to pundits hoped that Rajan will tone down his inflexible stance and reduce interest rates. But he kept repo rates unchanged at 7.25 per cent. </div><div> </div><div>Let’s leave the esoteric jargon aside at take a common sense look at the issue. All students of economics are taught some fundamental things. One is that inflation can be caused by factors called demand pull or supply push. The second is that higher inflation rates hurts the poor more than others. And the third is that high cost of capital makes companies less competitive. On all three common sense counts, the Rajan policy of being inflexible in cutting interest rates looks more fundamentalist than realistic. </div><div> </div><div>Supply constraints play a huge role in inflation in developing countries like India. Keeping interest rates at artificially high levels is not going to solve the supply problem; though it does tend to have a dampening effect on demand. Even during the UPA regime, the critics were wrong when they slammed the government for rising prices of food items like milk, eggs, poultry and some vegetables. The fact is, rising household incomes have meant that more and more “poor” Indians now consume such “elitist” food items. The solution is not to look at interest rates, but at ways and means of improving farm productivity. Even now, those who criticize the NDA government for the rising prices of such food items are wrong. And keeping interest rates will worsen the supply problem rather than ease them. </div><div> </div><div>That is because such high rates of interest makes a majority of Indian companies globally uncompetitive. Not every company is a Reliance Industries Ltd that can tap global capital and financial markets for cheap capital. For the thousands of enterprises in the small and medium industries category, high interest rates are a fatal burden on expansion plans. </div><div> </div><div>Lastly, persisting with high interest rates means there is little chance of an economic stimulus through increased consumer demand. Survey after survey has shown that investors and consumers have been postponing buying homes and cars because the interest rates are deemed too high. In developed economies where financial inclusion and penetration is virtually 100%, interest rate can indeed be the most powerful tool to send signals. But in a country like, the same can be folly. It is time, Rajan stopped persisting with this folly.</div>
