Are we playing against our growth story by hiking rates too fast? Swaminathan Aiyar explains

The World Bank has brought down India’s growth projection from 8.5% to 7.5%. I would say it might be even lower as these things are beyond our control, the war is not under our control. If the Russia-Ukraine war continues into 2024, our growth is going to be far lower than even 7%,”says Swaminathan Aiyar, Consulting Editor, ET Now

Just a month ago you said that there is a perfect storm that is heading our way. You also said that we will not collapse like Sri Lanka or Pakistan but we are certainly in trouble and you have maintained that these interest rates cannot solve the problem of inflation. Now that key interest rates have been hiked by 50 bps, how far will this and the mid May out-of-turn hike in interest rates go to tame rising prices?

This is just one step in a long journey. When you take one step, you do not say will one step reach you to the end of this journey? The world is going to go ahead with a series of increases in interest rates. The US Fed, European Central Bank, everyone. These interest rate hikes are going to carry on at least in the end of 2023 and into 2024.

So the journey is going to take us well into 2024 the world over and India. All that we are doing is keeping in step with the rest of the world. We are not doing something on our own, we are not doing something which we think will solve the issue as distinct from anybody else. We are saying everybody else is taking a step, a step, another step. They are taking a step and we too have to be in step with the rest of the world because if we are seen as being out of step, then people will say this guy does not understand what is happening and money can flow out of India in a big way.

We are simply conforming and keeping in step with everybody else. Will this solve inflation? It is one step in a journey and neither in the USA nor India does anybody think one step is going to complete the journey. One step is not going to solve the problem but it is a step towards a solution. In India in particular, everybody knows that if you raise interest rates, it cools inflation by slowing down the economy and saying demand is going down but if the particular inflationary shock has been caused by things like food and fuel, those are not highly sensitive to interest rates. Economic growth may be a little more sensitive than food and fuel.

At the consumer level, price rise pinches the lower middle class most when it comes to food and oil prices. So can a hike in interest rates bring these down? You are saying in those areas we may not see an immediate impact come in?

Absolutely and that is why the government tries to cut taxes, ban exports of various things. It may cut the import duty on edible oils. These are the kinds of actions which may help the consumer immediately but not rise in interest rates. There are different arrows in the government’s quiver for solving inflation like changes in duty structure or changes in the import export policy.

Those can help immediately in the case of food and fuel. RBI raising interest rates is an attempt of a much larger economy overall to try and cool down demand. These two should not be confused and the Reserve Bank is not going to solve the problem of food and fuel.

The inflation has been projected to rise to 6.7% by RBI. Can we expect more interest rate hikes in the future and if they are to come, is there the possibility that the RBI would be getting ahead of itself and cause the economy to slow down, if not drive into a recession?

No, the economy has to slow down. What is the meaning of raising interest rates? The aim of higher interest rates is to slow the economy. Let us be quite clear about this. Do not do it just for the hell of it! You are trying to slow the economy and to that extent, slow demand. What is very clear is that the world over, this is happening and therefore slowing of the economy is not an accident.

Slowing of demand, slowing of the economy is the aim of policy the world over now. Will this lead us into an absolute recession? We do not know. Abroad in America and Europe, there is the possibility that it will and it may be a mild recession, but everybody is aiming at slowing the economy and in India too, the economy will slow down. The aim is not to say growth will not be affected at all. Please let us not be naïve or stupid.

The World Bank in its latest projections says world growth is going to slow down to only 2.9% which is not very far from 2.5%. which is called a recession. The world over, the economies are going to slow, we are trying to slow it, we hope it will be short of a recession.

Of course a slowdown will happen but at this time when there are indicators that we might see stabilisation in oil prices, if home sales do not take as much of a dent as is largely expected and if those parameters are in control, then by hiking interest rates too fast are we actually playing against our growth story?

We are most definitely going against growth. The aim is to cool overall demand. This is not aimed at solving the crisis of war. That is a separate issue. There are specific things like oil and food for which, we have separate arrows in our quiver like changes in the tax structure in the import and export structure and what we are doing at the macro level interest rates is cooling the economy as a whole. The aim is to slow the economy.

With a hike in interest rates, it is natural to expect these home loan rates to go up. Our EMIs are bound to go up now. Will the rate hikes dent demand in the real estate sector? How much of an impact do you see in that key driver of the economy?

It will be significant. There is no point raising interest rates if the effect is not significant. So yes, wherever there is borrowing involved, demand backed by borrowing is going to diminish – be it construction, air conditioners or motor cars, anything bought on instalments. The interest rate will make EMIs effectively more expensive.

Now that the World Bank has cut India’s GDP growth for FY23 to 7.5% and our GDP per capita income is still below our pre-Covid levels, typically our understanding is that high interest rates puts less money in the consumers’ pockets. Are we to believe as an extension that our GDP growth is going to remain stunted with these sustained hikes in interest rates?

We are seeing all kinds of projections on what our GDP growth is going to be. Initially, they thought the growth this year might be 8.5% or even 9%. Those projections have been coming down and the World Bank has reduced it from 8% to 7.5%. The Reserve Bank has a far more conservative growth estimate of only 7.2%.

I would say in India, both the buzzers at RBI started with very cautious underestimates of the real possibilities, They were prepared for the fact that there might be a coming disaster. So, let us not predict what you thought might be realistic interest rates at that time. They said because disasters are possible, let us be very conservative and that is turning out to be wise!

The original projections of the World Bank at 8.5% was far too optimistic. Now the World Bank says okay may be only 7.5%. I would say it might be even lower as these things are beyond our control, the war is not under our control, the sanctions, the consequences are not under our control at this point of time. The consensus is that in Ukraine, there is going to be a long grinding war carrying on for many more months, maybe into 2024. If that is the case, then I am afraid it is very negative and our growth is going to be far lower than even 7%.

This article was originally published in Economic Times on June 9, 2022.

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