Policy rate alone not responsible for slowing growth: Subbarao

Mumbai: Amid widespread demand for cut in interest rate in the forthcoming monetary review to boost growth, RBI on Tuesday said the policy rate is not the only reason for slowdown in investments and the economy.

"The Reserve Bank maintains that interest cost is only one of the several factors that have dampened growth, and the increase in policy rate by the Reserve Bank alone cannot explain the investment slow down," RBI Governor D Subbarao said at the sixth annual Statistics Day Conference here.

"I have asked our economic research department to do a detailed study on the time-series relationship between real interest rate and investment activity. We expect to put out that report in the public domain in the next couple of months," he added.
His comments come two weeks ahead of the quarterly monetary policy review which is due on July 31.

Subbarao's decision to keep interest rate unchanged at the policy review last month to contain inflation evoked criticism from industry and the government.

Ahead of the policy, industry has stepped up demand for interest rate cut to boost economic growth, which fell to nine-year low of 6.5 percent for 2011-12.

The RBI Governor also raised issues concerning data gaps with regard to computation of inflation, national income and growth and underlined the need for rectifying them.

He also questioned the linkage between deceleration in industrial growth to 6.5 percent in 2011-12 and the increase in policy rates by 3.75 percent by RBI during March 2010 and October 2011. "... It is necessary to look behind the data and explore what lies underneath," he added.

On the current situation, the RBI Governor said, "The uncertainty surrounding economic activity has heightened in the post-crisis period. India is no exception."

He added that assessing India's potential growth rate, consistent with our objective of low and stable inflation, remains a challenge.

In its annual report for 2009-10, Subbarao said, the Reserve Bank had reported that the potential output of the Indian economy may have dropped from 8.5 per cent pre-crisis to 8.0 per cent post-crisis.

"Latest assessment following the standard filtering technique suggests that potential output growth may have further fallen to around 7.5 percent," he said.

Meanwhile, for getting a clearer picture of the price rise trend, Subbarao proposed a producers price index saying that the present structure of measuring inflation does not capture the price movement of services.

The Producer Price Index (PPI) will be better able to measure the average change over time in the sale prices of domestic goods and services, he said.

"In its present structure, the Wholesale Price Index (WPI) does not capture the price movement of services. Also, it is a hybrid of consumer and producer price quotes," he said.

Sellers' and purchasers' prices differ due to government subsidies, sales and excise taxes, and distribution costs, Subbarao said.

"For these reasons, it is, therefore, desirable that we move towards developing a Producer Price Index (PPI) that measures the average change over time in the sale prices of domestic goods and services," he added.

Subbarao further said core inflation gives a better picture of price trend as it is less volatile WPI-based inflation.

Core inflation is usually estimated by excluding food and energy prices from the basket of goods and services that represents a household's spending.

"The rationale for exclusion is that the prices of food and energy tend to fluctuate sharply and such volatility from the supply side, if passed on into the general price index, makes it difficult to interpret the overall trend," he said.

"The surmise is that core inflation, being less volatile, gives a better sense of future price trends," Subbarao said.

"If one takes a longer series of over three years, there is some evidence that core inflation does have statistically significant predictive power," he added.

Pointing out that most important statistic for the RBI is inflation, Subbarao in lighter vein said "I must admit that even at a personal level, I do not know how to interpret inflation.

"Twenty years ago, when I had a thick mop of hair, I used to pay Rs 25 for a haircut. Ten years ago, after my hair started thinning, I was paying Rs 50 for a haircut. And now, when I have virtually no hair left, I am paying Rs 150 for a hair cut. I struggle to determine how much of that is inflation and how much is the premium I pay the barber for the privilege of cutting the Governor's non-existent hair," he added.

He admitted that structural changes in economy over the past decade have created an unprecedented demand for commodities.

In the absence of a supply response, he said, this has resulted in a lasting change in the price level.

"Therefore, our headline measure of inflation will necessarily have a larger momentum than core inflation. In the RBI, we need to be mindful of these factors in interpreting the movements in headline and core inflation," he said.

Referring to the issue of poverty and financial inclusion, "We need a better understanding of the levels and patterns of income of the poor, their patterns of expenditure, their marginal propensities to consume and save, the risks they face and how they cope with them and the transaction costs they encounter in dealing with formal financial institutions."

RBI chief also underlined the need for comprehensive and higher frequency data on NBFCs and cooperative banks.

PTI