Murli Dhar

Interest Rate Structure to stay put but pressure is maintained by lobbies

“Bank depositors have nearly nobody to defend them, not even ministers whom they have elected to Parliament. Sometimes you hear the faint protest of consumer associations but that rumour dies out very soon as the media keep drumming it that BoM would not have taken the requisite business-friendly decision by failing to lower interest rates ever the more…”

MURLI DHAR

The Monetary Policy Committee (MPC) of the Bank of Mauritius (BoM) decided at its meeting of Monday last to keep the key repo rate unchanged at 4.9%. This decision was based on two main considerations, notably that the global economic outlook was continuing to remain depressed and there was a perceived risk of inflation picking up in the near term.

This could be interpreted to mean that should the pressure from degrading external economic conditions maintain itself, the BoM should carry forward sufficient scope to lower interest rate, something that would not be possible if the interest rate was taken to an even lower level from where it has fallen to already. Second, with headline inflation already at 4.2% in August 2012, conceivably going higher up towards the end of the year due to foreseeable rising commodity and energy prices as well as inflationary spill-over from coming upward generalised wage adjustment in the public and private sectors, there was no need to lower down the interest rate tool with which inflation can be controlled.

As usual, an expectation had been building up before the MPC meeting in the now well-known quarters that the BoM would have to lower the key interest rate. The usual argument was also widely publicised before the meeting to the effect that the domestic business sector was hoping for monetary easing in view of the classic difficulties it is traditionally and perpetually confronted with. In short, the private sector keeps asking at each round of MPC meetings that the interest rate be brought further down to God-knows-what-low-level and that the rupee be depreciated along as international competitiveness would otherwise be at risk.

This business lobby is so overwhelming that nearly no one other than the more sensible chaps at the BoM see the other side of the coin. What does a lowering of the interest rate structure produce in effect?

Consider the following to understand the stakes. Certain specific segments of the private sector have raised disproportionately large amounts of debt from banks (e.g., hotels, real and commercial estate developers, construction, etc.) and they desperately want to lower their interest rate servicing charge on those bank debts. This is done by causing interest rates to go down in the economy. These borrowers do not explain however why they borrowed money from banks both for short term needs and for undertaking capital projects. Capital project spending is normally met not from bank loans but rather from shareholders injecting capital into the companies.

Bank loans are meant for short term requirements (called day-to-day ‘working capital’) and not for funding capital projects. Local businesses having gone to banks for borrowing both ‘working capital’ and ‘investment capital’ in our case constantly lobby therefore for the interest rate to be reduced in order to get down to paying as little as possible by way of their debt servicing. It is not the fault of the BoM if banks and their business customers did not foresee that the going may not be as good as it has been all the way and that funding of projects should have been structured correctly. It would not be the fault of the BoM either if the borrowers failed to honour their huge obligations and put the very banking system at risk with bad debts. In fact, that would be putting depositors’ money lying in the banks at serious risk.

Looking at it from another angle, banks are mere intermediaries. They take money from savers and depositors to pass it on to the concerned businesses as loans. If banks’ lending rate to businesses has to go down (when the MPC lowers the key repo rate), the interest rate the banks pay out to depositors has to go down as well. The pressure ultimately of misconceived borrowing plans of businesses and their banks comes to fall on the depositors at banks who are successively made to accept lower interest rates on their deposits as the MPC merrily goes on reducing the country’s interest rate structure under private sector pressure.

In this manner, the business risk that should have normally been taken by shareholders in businesses is practically passed on to bank depositors. The latter have nearly nobody to defend them, not even ministers whom they have elected to Parliament. Sometimes you hear the faint protest of consumer associations but that rumour dies out very soon as the media keep drumming it that BoM would not have taken the requisite business-friendly decision by failing to lower interest rates ever the more.

Yet another dimension of the interest-lowering advocacy has to be understood from the latter’s impact on the rupee’s exchange rate. Low domestic interest rates shy away capital inflows and even keep off domestic foreign exchange earnings outside the country. The result is that the amount of foreign exchange available on the domestic market for its day-to-day needs gets reduced in the process. This is what is meant when it is said that demand for foreign exchange exceeds its supply on the market. This situation of excess demand leads to a firming up foreign exchange rates or, what is the same thing, depreciation of the rupee. It is a familiar story that has been playing out for decades now.

As a result, business exporters keep getting more rupees for providing the local market with the same amount of foreign exchange as before. As the businesses fill up their pockets with more rupees in the process, it is consumers at large who have to bear the consequences. As the rupee depreciates, imports become more expensive in rupee terms. Traders, apart from jacking up routinely prices of imported commodities in the given ultra-liberal no price control model, simply pass on the higher costs of imports due to induced rupee depreciation to the consumers. The ensuing inflation hits the consumer directly while making the savers’ real return from their bank savings yield negative returns after offsetting the amount of price inflation, i.e., eating away into their capital.

In this model, the public is in double jeopardy. It gets lower and lower amounts of interest income on its savings. It also pays up increasingly higher prices from out of its given budget. This is what obtains in the ultra-liberal laissez-faire model that is consistently applied by our policy makers. The public is perpetually squeezed for the benefit of a few. These few are supposed to be working for the welfare of the public, notably by providing employment which never ceases being used as argument for all manner of policy arguments made out from time to time.

The question in the face of this kind of oppression is: is there someone somewhere in this republic who will stand up and rid it of this dubious game which otherwise risks being played for eternity? At one time, there were champions for a good cause. But this seems to be a vestige of a past that hardly attracts even social organisations supposed to defend the plight of the 99%. Even the IMF can be canvassed, it seems, to give its support to rupee depreciation in a manner of shifting the entire burden of effective policy making on to the central bank when policy makers fail to make tangible economic progress elsewhere. How can we seek any comparison with a place like Singapore where its Monetary Authority not only sees that the country’s interest rate sits where it should but even employs an appreciating currency to fight out inflation? Unlike in that place, here we have the knack to mix up politics in each and every issue so as to sway matters the way it pleases a tiny but powerful minority. This minority does not need any Best Loser System to make its point from time to time, even if that involves dragging down our central bank’s autonomy to its lowest expression.

MURLI DHAR

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