'Romancing the rentier', The Hindu, January 25, 2003.

There is a sphere of economic policy in India where the piety of its planners, the vested interest of its rentiers, and the nostrums of the IMF have met in cozy comfort. This is a predilection for high interest-rates. The regime is beginning to look a trifle wobbly of late, however, with the nominal interest rate moving steadily downward for over a year. This has aroused moral indignation based on the impact this is assumed to have on the level of saving, believed to entirely depend upon financial incentives, and thus the health of the economy. A version of this is typified by a letter to the editor of this newspaper dated January 7 remarking: "One obvious fallout of the Kelkar recommendations (if implemented) will be to discourage the saving habit among the middle class, and to encourage all the surplus funds to flow into the speculative share markets. Can any economist, or government spokesman for that matter, explain how this will serve the public interest?" The allusion is to the proposal that tax concessions for saving be removed. Whether focussed on the rescinding of tax breaks or the declining interest rate, as the case may be, a pressure group for savers appears to have emerged. Without holding any brief for Mr. Kelkar, one might yet query the wisdom of over-emphasising the role of saving.

The first illusion one must dispense with is that more saving, dependent upon the interest rate or not, is per se good for the economic system. Surprising as it may sound, it is not always so. For any increase in saving needs be absorbed by the economy. What determines whether this happens? The contemporaneous volume of investment. Whenever the volume of saving is greater than the volume of investment, the economy must per force contract. That is, the level of income will decline to bring saving and investment into equality. How does this get done? Via a mechanism that links saving to income, as the level of income declines do does saving. This is made necessary for investment is independent of income. It is dependent only upon the interest rate and the sentiment of the investing class. 'But, why need saving and investment be brought into equality?', you might ask. They must be, for an economy is also a flow of income, and while saving is abstinence impeding the flow, investment is spending quickening the flow. For the system to be at rest the forces of resistance and expansion must be balanced. Whether the economy ever comes to rest is a moot point. However, while these two forces work on income in contrary ways, investment governs savings.

            How do interest rates come into all this? Very straightforwardly, actually. If the interest rate is left to market forces, barring imperfections and informational asymmetries, we may expect to get a rate that equates saving and investment. Now, on the other hand, were the rate of interest to be pegged, by government intervention, above the market-clearing rate we would be left with saving exceeding investment, with saving having been encouraged and investment discouraged. Savers are clearly benefited of course. However, we are clearly sacrificing additional income that may be assumed to have been generated were the interest lower and the consequent level of investment higher. Essentially, while additional saving may be a good thing for the individuals who are doing the saving, it is not necessarily good for the system as a whole. Indeed we can conceive of situations where an attempted increase in the level of saving must lead to its actual decline, for aggregate income decreases as consumption spending inevitably contracts, dragging along the level of saving, leaving everyone worse off. This discovery was aptly named the paradox of thrift.

            As savers prefer high interest rates and investors are benefited by lower ones, a reduction in the interest rate is often represented as a straightforward distributional conflict - which it is too - and the committed have rushed to take up cudgels on behalf of one or the other group in accordance with their predilection. But the story is not so simple though , for we may yet conceive of a set of players other than rentiers and capitalists who invest. These are the suppliers of labour power, or the workers if you please. Employment is more directly related to the income generation process than it is to saving. This is so, for investment expenditure leads to an expansion of income in an economy with unemployed resources, both capital and labour. If investment is discouraged due to high interest rates it does no good to the unemployed. This recognition opens up a window of opportunity in evaluating the current debate on an interest-rate policy for India.

            There is a fine approach to evaluating our social arrangements, which an economic policy always amounts to. The focus is on social justice, and the originator of the approach is the political philosopher John Rawls. Rawls had proposed the use of the 'maximin' principle in choosing between alternative arrangements. Accordingly, we are encouraged to adopt arrangements that maximise the pay-off of the person or group at the bottom of the scale, or the least advantaged in society. In this sense Rawl's proposal had amounted to a theory of justice, indeed the title of a celebrated work. However, long before it had been patented in Massachussetts, the germ of the idea had been berthed in Gandhi's notion of antyodaya, but we chose to ignore it in post-Independence India. It is quite extraordinary that an idea of justice has played such a small role in our frenzied discussions of economic policy. Armed with some goal of justice, however, we begin to make sense of interest-rate policy. If high interest rates impede the expansion of output and employment because investment is deterred then the unemployed are worse off.

High interest rates disproportionately favour those with the income to save. On the other hand, workers may be worse off for they never get to earn the income that may have been generated from the investment stymied by a higher cost of borrowing. Even after the lamented decline in nominal interest rates, the inflation-adjusted or 'real' rate in India remains high, both historically and today, in a comparison with the economies of the OECD, the Far East and the Arabian Gulf. India's interest-rate regime may have served an altogether more sinister role though. High interest-rates may have attracted wilful defaulters willing and able to face the stigma and entanglements of an otherwise toothless bankruptcy law which includes the discredited BIFR. It is a well-known result in economic theory that high offer rates are the mechanism whereby dubious entrepreneurs solicit funds. Hence the expression 'junk bonds'. However, while junk bonds are the unacceptable but avoidable face of American capitalism, in India high interest rates have been thrust upon its workers by the Indian state. It is likely that this policy has not only encouraged entrepreneurs of bad faith but it has bank-rolled their deceit with the tax-payer's money. The non-performing assets of the public-sector banks, estimated at over rupees 50, 000 crores, partly originated in loans to privately owned firms that had never intended to repay.

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