"(Times Of India) Reduction in interest burden could possibly prevent more companies heading towards bankruptcy • The finance ministry has stressed that it will stick to the path of fiscal consolidation. • After the mid-year review suggested that fiscal targets may need to be revised, many economists emphasised the benefits of staying put on the announced path of fiscal consolidation. • First, the debt to GDP ratio would remain under control. Equally important, the finance minister would maintain his credibility, particularly since he has already deviated once from the path. • The decision of the government to stick to the path of the announced fiscal targets is good not just in the long run. It is also more likely to help in the short term. • One immediate gain of sticking to the path of consolidation will be to create space for monetary policy easing. The sharp decline in global commodity prices and the slowdown in demand in the domestic economy have reduced inflationary pressures. • The policy interest rate — that is, the repo rate — stands at 6.75 per cent. Unlike, say, in Europe, where there is no scope for cutting the policy rate that is near zero, in India, there is ample scope to cut it. But while in principle the policy rate can be reduced significantly, the question is how to give monetary policy the space to do so. • A fiscal stimulus would increase the likelihood of demand rising and pushing up the inflation forecast. While deciding the policy interest rate, monetary policy makers target the forecast of inflation and analyse the pressures of demand on core inflation. • With a slowdown in global demand, investment and domestic demand, a greater easing of the stance of monetary policy may be more possible today than perhaps even a year ago. This opportunity could be lost if the government had chosen to pursue a policy of fiscal expansion. • In theory, this may hold, there are two reasons this may not be true in India today. • First, the capacity of the government to spend is limited. A large share of the capital expenditure allocated in Budget 2015 is yet to be spent. Many good plans have been approved and money allocated, but the shovel is yet to hit the ground. While, in theory, public investment can spur private investment, limited state capacity may be one reason why the magnitude and lags involved may make this strategy less optimal than theory suggests. • Second, private companies are unable to repay the interest on their debt. Banks are increasingly seeing loans get in trouble. High interest rates hurt not just the companies whose revenue growth has fallen sharply but also banks whose stressed assets have been on the rise. • For private investment to pick up, companies need to have the ability to borrow, and banks the ability to lend. Raising demand through a fiscal stimulus does not address the balance-sheet stress of companies and banks, while a reduction in interest rates would. • Early in 2015, the government and the RBI adopted inflation targeting as an objective of monetary policy. Inflation targeting is adopted by governments and central banks to tie down their own hands. • The best strategy for the government, therefore, lies not in giving up the inflation target, or in changing the measure of inflation adopted, the consumer price index, because it is higher than the wholesale price index, or in changing the glide path towards the target, but in creating the conditions that would keep inflationary pressures down. • The RBI should respond to this commitment by cutting interest rates.However, a reduction in the interest burden could possibly prevent more companies from going towards bankruptcy. This is a greater need of the hour than higher demand. OTHER PRACTICE QUESTIONS

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