Repo debate: Cheaper credit doesn’t always spell faster GDP growth
There are growing calls for a reduction in the repo rate. The argument is not so much that inflation has come down, but that potential growth will get affected. This is contrary to the majority view that as growth is very much on target, with the Reserve Bank of India (RBI) projecting it at 7.2% for the year, monetary policy focus can remain on inflation control.
This is different from the stance RBI took during the pandemic, which was to do everything to protect growth. But that was a black swan event, and using the same logic today, when the economy is cruising along well after registering a high growth rate of 8.2% in 2023-24, may be misplaced. Conceptually, when interest rates are high, companies borrow less, which slows down investment.
That’s what policy is supposed to do. However, in practice, it is not that simple. Companies invest when they see business opportunity and capacity utilization rates matter more.
If there is vibrant demand, higher interest rates will not be an impeding factor for investment. In fact, for non-financial companies, interest cost as a proportion of turnover is just 3-4%; and is lower than the share of power expenses or promotion and distribution costs. Hence, just as how higher raw material prices do not get in the way of production, provided there is demand, interest costs do not.
When investment decisions are taken, companies work out their return on capital based on future revenue streams adjusted for costs and compare them with the market rate of interest. Higher costs get transmitted to final prices when conditions are good, as is the case presently. Now, in the traditional world, when interest costs were fixed, this equation was relevant.
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