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29 suitors, 1 tuxedo
RBI should have 29 different interest rates for 29 different states based on their growth patterns and the globally-practised Taylor’s law

The RBI’s interest rate fixing in India is a scattershot approach, which assumes that the country is uniform, which is not the case in reality. A uniform interest rate, therefore, is a wasteful proposition in a country that varies from the prosperity of Punjab to the utter neglect and backwardness of Tripura – both economically and socially. Progressive states like Punjab, Haryana, Gujarat, Maharashtra, Tamil Nadu and Karnataka have high per capita income, low level of hunger, better infrastructure and low poverty rate, thus inspiring confidence in the minds of investors. On the other hand, states like Orissa, Rajasthan, Bihar, et al find it difficult to attract investment. In this light, the current system of blanket interest rate/lending rate is clearly out of sync.

Instead of implementing a uniform pan-India interest rate, the RBI must impose higher interest rates in states that offer business opportunities to investors on a platter and offer discounted rates for investors opting to invest in regions that are still not progressive. Gujarat is another manufacturing power house, but unlike Punjab, it is an industrialized economy with a very high growth rate and should attract higher interest rate from RBI. If we focus on the growth trend line among these states, we figure out that between 2006-07 and 2011-12, Haryana (growth rate between 17.1% and 21.66%), Tamil Nadu (growth rate between 12.98% and 20.44%), and Maharashtra (growth rate between 11.39% and 20.38%) are among the forerunners of the country’s growth trajectory. Thus, RBI should push up the lending rates in proportion to the growth pattern in these states.

On the other side are middle income states like Andhra Pradesh, Kerala and West Bengal. Andhra Pradesh is mainly driven by agriculture (even though there is a considerable concentration of IT and manufacturing units in and around Hyderabad), Kerala is driven by agriculture and tourism, while West Bengal is languishing with hundreds of sick manufacturing units. These states are mainly agriculture-based, where high interest rates can further exacerbate the problems that they face. Even though Andhra Pradesh and Kerala had a decent run in growth with 2011-12 growth rates being 14.82% and 17.94% respectively, they have some distance to go to catch up with more advanced states. West Bengal, on the other hand, has had a middle-of-the-road growth projection between 13.65% and 18.6% in the last 6 years.

The laggards are the BIMARU states and North East with low per capita SDP and low growth rate. The longer this impasse endures, the harder it will be to recover. Bihar (which is at the bottom of the table), however, has started a recovery of sorts, clocking 20.39% growth in 2011-12. However, it is on small base that can wither away as the base expands. Orissa, with 8.49% growth (2011-12), Jharkhand with 11.89% and North East with a consistently depressed growth rate of below 10% are consistent bugbears for our policy makers. Needless to add, interest rates must be lowest in these zones that badly need a breath of fresh air on structural reforms.

Furthermore, economist & Nobel laureate Taylor explained in his widely accepted Taylor’s law that if inflation augments by 1%, the interest rate should rise by a little over 1%. He also remarked that a rise in total output by 1% should correspond with a 0.5% rise in interest rate, and when it falls by 1%, interest rate should be cut by 0.5%. However, RBI’s methods in this direction have confounded everyone. When SDP fell for some states (like in Karnataka, last year’s growth fell to 14.92% from 17.35% the previous year), interest rate has been uniform. Similarly, when the output rose, RBI did not act in accordance with Taylor’s principle. Even in the national context, RBI’s handling of interest rates has not been in accordance with principle.

To manage the diverse economic and social intricacies that are so peculiar to India, RBI must consider each state as whole, study different economic and social aspects, and then implement policies that are best suited for that particular state. India is an exceptional country with extraordinary diversity – it’s almost like the entire Europe clubbed into a single economy. And to deal with that, each state should be treated separately and subtly to make most for each of them.

By:- Sayan Ghosh & Sray Agarwal

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