New Delhi, Oct 6: In its recommendations for the mid-term review of Monetary Policy 2007-08, CII expressed concern over high interest rates affecting investments and growth and suggested that the time is right to recognize the need to reduce interest rates, which is pivotal to sustain nine percent plus GDP growth.
The RBI had introduced tight monetary measures to control inflation and liquidity conditions in the economy. With inflation at less than the lower limit of RBI's tolerance levels of four to 4.5 percent in the medium term and given the strong macro economic conditions, it is time to review the tight monetary policy regime, said CII.
Inflation is under control and has declined to 3.23 percent for the week ending 15 September 2007. However, Bank credit has declined from a high of about 33 percent in June 2006 to about 23 percent% in August 2007. RBI's efforts to manage liquidity seemed to have worked. However, this has had a lagged impact on the Industrial output. IIP growth declined in July 2007 to 7.1 percent from 13.2 percent in July 2006.
A CEOs snap poll conducted by CII revealed that high interest rates are a cause for concern and majority of the CEOs expect that the Interest rates should be reduced to encourage greater investment rates. The CII CEOs snap poll revealed that 69 percent of the CEOs expected the interest rates to be lowered to about 12 percent (PLR) from the current level of 13.25 percent.
India would need investment rates in excess of 36 percent of GDP to achieve 10 percent GDP growth in the medium term, which is important to increase per capita income and reduce income inequalities.
Moreover, the appreciating rupee has also had an impact on the profit margins of exporters as well as SMEs. According to the CII's 19th Business Outlook Survey, for Micro Small&Medium Enterprises, 71 percent of the respondents expected a negative impact on their bottomlines due to surging value of the Rupee vis-À-vis the US Dollar.
Furthermore, following the rate cut by the US Federal Reserve by 50 basis points will provide greater interest rate arbitrage opportunities and would trigger greater foreign investment inflows in the economy. FII inflows in the last seven months have already touched seven billion dollars. While the RBI has been engaged in sterilizing the rupee, reducing the interest rates could be of help to exporters especially smaller exporters in reducing costs to recover their lost margins due to appreciating rupee and also help reduce the interest arbitrage to control the surge in FII inflows.
CII strongly feels that reducing interest rate would go along way in boosting demand and investments. It would also reduce the operating costs of exporting SMEs who have been facing decline in profit margins due to appreciating rupee. The impact of high interest rates have been severe on SMEs, especially exporters who have been the worst due to the appreciating rupee and has eroded their profit margins significantly.
In its other recommendations on monetary policy, CII said that in the US, the Federal Reserve takes the unpredictability out of its measures to the extent possible, by preparing the market before an intervention. The RBI could follow a similar practice, in order to ensure that there are no knee jerk reactions in the market.
Foreign Exchange (forex) hedging is a complex subject. In today's volatile forex market all exporters need to hedge to protect their realization. RBI could create a special window in domestic banks to help small exporters hedge their forex earnings.
Lack of a foreign currency exchange leaves Indian industry in a disadvantageous position when there is significant volatility in currency markets. A formal hedging mechanism for corporations to take positions on foreign currencies is absent.
Growth forecasts should not be made keeping inflation in mind, but inflation forecasts should be made keeping growth in mind. Must realize that for the first time the economy is on a virtuous cycle of growth, which has the potential to create wealth on a sustained basis, which could then be distributed. Therefore, must not sacrifice growth at any cost.
Infrastructure investments requirement has been estimated to be 475 billion dollars for the next five years. In a recent CII CEOs poll on Infrastructure revealed that ECBs were one of three most important sources of finance for infrastructure, especially in the light of lack of deeper corporate bond markets, the recent cap on ECBs may be relaxed for investments in infrastructure projects.