These are the times when the policy makers around the world miss someone like Nostradamus the most. All distinguished policy makers feel that they know exactly what to do to make the limping economy overcome the fiscal cliff. But the results of the policies being implemented tell a different story. Every policy change being made is old wine in a new bottle. Any new policy change we see nowadays makes us say oh wait I have seen the Japanese do that. Japanese have tried every possible move on the board to get out of the effect of the lost decade. The US Federal Reserve Chairman, Ben Bernanke called it a self induced paralysis. He stated that the central bank of Japan hasn’t done enough on its part to rescue the economy. They simply traded one form of federal aid for another. It turns out that Fed might not know how this will end.The Indian policy makers in recent times made some seemingly tough decisions.But this does not deny the fact that the much needed reforms have been stalled for quite some time. The reforms even lack a direction. Faced with high inflationary situations in economy, RBI has been raising interest rates through an increase in Repo rate till October 2011. RBI’s idea behind this repo rate increase is that the banks will increase their rate of interest which will result in decrease in demand for loans thereby decreasing the demand for real estate and other such debt driven investments in the economy and hence the inflation.
When the United States was hit by recession in 2008, The Federal Reserve Chairman came up with Quantitative Easing. There have been two rounds of Quantitative Easing since then. Third round is underway. The impact of each QE round has diminished greatly. One apparent oversight is ignoring the behavior changes of Companies and Individuals during the tough times. The primary causes of inflationary pressure in Indian economy are food inflation, primary commodities inflation and fuel and power inflation. Since no one takes a loan to buy his food grains, the high interest rates didn’t work. What it actually has done is, increased the difficulty in setting up a new business. High cost of capital added to the existing woes of lack of skilled labor and regulatory hindrances making it very tough to start a new business venture. So the rising inflation failed to translate to growth.
By mid of 2011 Fed announced that most of the banks that took the bailout money returned back the money yielding a profit to the tax payers. But once we take a deeper look into how actually the small banks returned their money, it turns out they repaid their debt to Fed by borrowing from fed. Under the small business jobs act, the small banks found the facility of cutting their yearly 5 percent dividend payment rate to as low as 1 percent provided they meet certain lending targets. Many small banks seized this opportunity and got the cheaper loan to repay the original bailout money. In India, we seem to have hit the high of interest rate cycle. With the existing monetary policy, the move to regain control on the inflation as well as growth rate seems to be tougher. Capital market reforms are the need of the hour for both debt and equity markets in India.