On interest rates urjit patel is bang on
Reserve Bank of India (RBI) governor Urjit Patel did the nation, not to speak of his own reputation, a major service by speaking up against large-scale lowering of interest rates by means of subventions from the Union Budget and against credit guarantees. In a well-functioning market, the interest rate offered to a particular enterprise includes, besides the cost of money in general, a risk premium that is tailor-made for that enterprise in its particular line of business, reflecting the likelihood of the said enterprise succeeding. Distorting interest rates is likely to end up misallocating resources. Money has alternative opportunities for deployment. If a risky venture could attract capital because someone is willing to subsidise a part of its interest cost, it could, in the process, deprive another venture that has lower risk but does not have anyone to subsidise its interest cost, not just of capital, but also of land, workers, power, entrepreneurial energy — of a chance to form and get going.
The inherent risk, which cannot be mitigated by an interest subvention, might sink that project that did get funded, and the result would leave society poorer for not having funded the intrinsically less risky project in the first place.subvention, might sink that project that did get funded, and the result would leave society poorer for not having funded the intrinsically less risky project in the first place. A similar logic applies to credit guarantees by the government. Tampering with the cost at which capital is available to an enterprise is a recipe for misallocating and wasting resources, lowering welfare in general. Of course, interest subventions and credit guarantees are useful and necessary in small doses, to compensate for risk perception arising from lack of information and large transaction costs in resolution, in case of failure.
Coming, as the RBI governor’s warning does, in the wake of the prime minister announcing significant interest subventions on housing and enhanced credit guarantees in his New Year Eve address, it makes the point that fear of political displeasure will not prevent Patel from making public his professional views on vital matters. Giving that message is as vital as the sense on interest rates, in the interest of the RBI’s institutional image.
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