Column: The interest rate-growth disconnect
In the last two years, the Reserve Bank of India (RBI) has been constantly chided by everyone for slowing down the growth process by maintaining a high interest rate regime. The view is that by keeping interest rates high, investment has slowed down, which has affected growth. This has happened without really bringing down inflation, which is more structural in nature.
RBI, on the other hand, has always argued that the link between interest rates and investment is tenuous, and there is evidence to show that low interest rates by themselves cannot bring about growth. This argument sounds right because nobody borrows money merely because it is cheap—like merely because interest rates come down, one does not buy a house as other conditions also matter such as own income and price of property. One does tend to look at overall economic conditions, which include not just the economic numbers but also the policy environment before taking a call to invest. Therefore, industry would be looking at future demand conditions, current capacity utilisation, future interest rates, etc, before taking a final call.
The best way to see where the answer lies is to look at data. The accompanying table looks at the repo rate, GDP growth rate, gross fixed capital formation rate and growth in credit since FY01.
The table provides some interesting observations. The first relation that can be examined is between interest rates and