As India becomes an important player in a globalised economy, high interest rates tend to have a bigger impact in holding back growth than in curbing inflation, Kaushik Basu, the outgoing chief economic advisor, tells Gautam Chikermane in Part 3 of an interview.
Gautam Chikermane: Let's come to the question that links growth and inflation: interest rates. This is the third leg so to speak --- low growth, high inflation and high interest rates. I believe, RBI has to slash its rates. It doesn't have to cut rates by 25 or 50 basis points but slash them by 2.5 percentage points. That could kick start the economy during these times of policy paralysis. Do you agree?
Kaushik Basu: I may not agree with you on slashing rates but I may point towards the direction which is similar. This is a very deep question, an intellectual problem and has to be dealt with correctly. This is one of the disputed areas within economics, where the best professionals will have diversity of opinions, which is not the case with every topic economic policy. Economists agree on a variety of things but this topic is an open intellectual matter.
Gautam Chikermane: What is your view?
Kaushik Basu: I believe that high interest rates in today's globalised world tend to have a bigger impact in holding back growth than in curbing inflation. So, to that extent, it is not the most effective instrument. This used to be an effective instrument in older days when the world was not globalised. And, therefore, my inclination is to go in the direction of lower interest rates to stimulate growth, even though I would not do it as sharply as you're suggesting. Some of our inflation today is supply driven, so if can get growth up and more goods come into the economy, this may ironically have a dampening effect on inflation.
Gautam Chikermane: It will also create jobs.
Kaushik Basu: I agree.
Gautam Chikermane: So, why isn't RBI cutting rates?
Kaushik Basu: There is a whole body of thought that the interest rate tightening is the right way of inflation control. I am aware that what I am suggesting is a contrarian view and I am fully aware that there is no clinching answer to this problem. The RBI does an impressive amount of research and it has a solid record of responsible policymaking. Lowering interest rate is an out-of-the-box action. And RBI has to worry that if it's going to do something out-of-the-box, like lowering interest rates during high inflation, and it backfires, it will have to take the criticism. So on balance RBI is going along with what is the standard safe option.
Gautam Chikermane: If you were RBI governor, would you cut rates today?
Kaushik Basu: If that happened, I would have far more access to research than I have now. So answering this question in advance is a hazard, like cutting interest rates in the middle of an inflation. But, on balance, my answer is yes. I would risk the hazard and cut rates.
Gautam Chikermane: How do you relate to this: despite high interest rates, inflation has not come down? Global commodity prices or food prices that hit their highs in 2010, have nothing to do with RBI's interest rate policy and will continue to move the way they are.
Kaushik Basu: I am agreeing with you on the direction of interest rates. The thing I'm not agreeing with is treating this as a no-brainer. Take the extreme example. You suck money supply out of the Indian system, basically drain the body of economy of blood, inflation will collapse --- no matter what happens to international prices. Crude prices can go through the roof, Indians won't have the money to buy. So you can play this deadly game of just draining money supply. Just because global prices are rising it's not a fait accompli that our prices will rise. In my view, the right direction to go at this point of time when our growth is slowing down sharply and inflation is gently slowing down is to lower interest rates, and help get the growth back up. But to treat this as the obvious policy is to do intellectual injustice to a deep and admittedly difficult policy matter.
Gautam Chikermane: Globalisation seems to be a common problem for India on all three fronts --- growth, inflation and interest rate. Is India so globalised that whatever it does on the policy front, it will have little or no impact?
Kaushik Basu: I will not put it that strongly but its true your instruments of policy begin to get blunted in a globalised world. There are various things that you can do in closed economy, but not in a globalised economy. On a variety of policies your power gets weakened. If you want to redistribute income massively, you can do that in a closed economy, not in a globalised one.
Gautam Chikermane: That gives ammunition to its detractors to say that let's stop globalisation.
Kaushik Basu: I don't go along with that at all because the reason for our relative prosperity compared to 20 years ago is because of globalisation. To jettison globalisation because it has some negative side effects would, in my opinion, be utterly wrong.
Gautam Chikermane: So, would it be fair to conclude that sovereign power is falling with every step a country takes towards globalisation?
Kaushik Basu: Absolutely. The political power of the sovereign goes down with every move towards globalisation. And also, your power to do things in other countries increases. Economics has become an instrument of global political and even military strategy. I don't know if this is good or bad but I am sure that for any nation to fail to recognise this would be a folly.
Gautam Chikermane: So, maybe the governance structures of the past now need to break down and be replaced by new ones?
Kaushik Basu: We need more effective global governance systems. We already have WTO guidelines for trade and ILO for global labour policy. But we also need fiscal policy, monetary policy coordination. This immediately raises questions about global democracy. I have written a lot on this. It's a very difficult juncture for the world but the fact is that the world has globalised in terms of economics but it has not globalised in terms of politics and this is creating a kind of tension which we've never seen before.
Gautam Chikermane: Finance is very easy to move, people aren't. So, India's strength in terms of labour faces issues like citizenships but for capital it is a seamless flow into India.
Kaushik Basu: Sure. Some right-wing groups in industrialised nations will argue for a complete free flow of capital between nations, since capital is a factor of production. But if you ask them about labour movement across nations, they will either run away without answering or give you a convoluted no for an answer.