India is giving interest as if it was a junk bond. BUT is very safe.
That's what you think! Read the following article excerpt. It explains two alternatives -- one that provides short-term comfort but long-term pain, and another that necessitates taking short-term hits but gives India a fighting chance over the long-term.
No prizes for guessing what alternative India has chosen to take! :-)
Dipy.
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The challenge can be met and there are two ways in which
the Government can do so. The first is easy but leads to
ruin. The second is harder but will lead to an overall
strengthening of the economy and an increase in private
investors' confidence in the country. Mr. Sinha is bound
to receive both kinds of advice. He would do well to
weigh his decisions carefully.
The easy way is to raise interest rates yet again ( for
instance by one per cent or more at the advent of the
busy season, if not earlier). Real rates of interest are
already five to six per cent above world rates and this
has played no small part in attracting portfolio capital
to India in the past two years. Despite the increase in
fragility of the economy after the sanctions come into
force, there will always be enough speculators in the
international market prepared to bring money into India
for short term gain, if interest rates are raised high
enough. The additional inflow could easily offset the
fall in bilateral and multilateral lending.
But this is the road to Thailand. An increase in
interest rates will further depress the share market,
further raise the cost of new investment and therefore
prolong the drought in investment. This will extend the
stagnation of industry and the slowdown in economic
growth. At the same time it will prop up an overvalued
rupee and perpetuate the stagnation of exports. Sooner
or later confidence in the economy will evaporate and
foreign money will go rushing out. The rupee will
collapse, and India will not even have the option of
turning to the IMF for short term help. The terms that
will be set by the U.S. for a bail-out will then be
entirely political and will crush India's remaining
sovereignty.
The other, indeed the only, course that is open to the
government is to lower the Bank Rate by another two
percentage points at the very least, and lower the cash
reserve ratio. This will cause a sharp fall in deposit
rates, a transfer of money to the share market, and a
fall in the cost of investment. The resulting increase
in investment will kick start economic recovery. Lower
interest rates will also lead to an outflow of short
term foreign money and a fall in the value of the rupee.
A 15 to 20 per cent devaluation will not only make
exports competitive once more, but give the Government a
windfall increase in customs revenue of more than Rs.
10,000 crores, which will help reduce the fiscal deficit.
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