The Centre for Monitoring Indian Economy (CMIE) has said that the past data would not indicate that a reduction in interest rates necessarily translates to rise in investments. In its previous meeting, the RBI’s Monetary Policy Committee (MPC) slashed repo rate by 25 basis points and the change its stance from neutral to accommodative.
With inflation largely under control, the MPC decided to accommodate growth concerns, boost aggregate demand and spur investments. However, the Mumbai-based think tank said that the decision to cut interest rates might fail to encourage higher investments from companies.
The RBI has brought down interest rates substantially – by 75 basis points in four months. At the margin, this should spur some investments. However, the past data of companies do not suggest that a reduction in interest rates could lead to pick up in investments, CMIE said in its report.
The central bank recorded the policy rate cuts of 50 basis points between February and April 2019 that resulted in very low weighted average lending rate of 21 basis points. If the same holds true for the latest policy cuts announced in June, then the only variable that could lead to a rise in private investments is relationship between interest rate changes and changes in investments by companies, CMIE said in its report.
The expectation is that lower interest rates would hurt higher investments by companies. We will try and find if such a relationship holds in reality by studying the aggregate behaviour of large and medium companies, the report said.
For this, CMIE analysed the relation between interest incidence and net fixed assets of companies in its database. Interest incidence refers to the frequency of interest rates between 1990-91 and 2017-18. While, net fixed assets refers to the net investment by companies to acquire assets. Interestingly, the relationship between interest rate and investments can change dramatically at the mid-point of this 28-year time period, CMIE noted in its report.
In the first half of the 28-year period, ranging between 1990-91 and 2003-04, the analysis showed higher interest rates associated with higher investments. As effective interest costs declined during this period, so did growth in net fixed assets.
During the latter half, the interest incidence and growth in net fixed assets was seen to be quite random, CMIE reported. Overall, while interest costs scaled upwards, growth in net fixed assets plummeted towards the end of the period.
The drop in growth of net fixed assets during the last two years seems to be much sharper than can be explained by the elevated interest incidence during this period, CMIE said.
The problem with investments is apparently not interest costs but the low asset utilisation faced by companies. The sales to net fixed assets ratio of non-finance companies, at 2 times in 2017-18, was at its lowest in the past 28 years, the CMIE report further added.
