Cut Out July 2, 2012

Jul 6, 12 Dear Mr. Srinivasan, Thank you for your email. I think you have misunderstood my article, and my explanation re one comment by Rajesh so let me try to explain again. I stick by my simple arithmetic example, by the way, and I do think it makes sense for India to have far lower interest rates now. Even 8.88% is far too high, in my view, with appropriate selective credit regulation mechanisms in place (which we dont have yet). As I mentioned, it does help to study/know something about the subject/s before coming to ones conclusions. The subjects include the domain of finance (e.g., Modigliani-Miller, the financial logic of P&L -> Balance Sheet -> Cash Flow -> GDP, tax and investment) and economic history, as in the case of Switzerlands successful use of zero rates to combat an overvalued currency, contrasted with the less successful attempts in Japan, the US, and the UK. Also the discipline of process flow charts and simulation models, i.e., dont simply make assertions; show how it works in practice. What you saw as my abandoning my arithmetic example is in fact my trying to explain how complicated it gets if one takes the point simplistically to assert a straw man fallacy, e.g., if a low rate is better, why not reduce rates to zero, or negative? Why not maximize debt to 100% -- this is where Modigliani-Miller comes in. Because either choice will end in bankruptcy. You may be aware of two other Nobel winners, Scholes and Merton, who founded Long Term Capital Management, and because of overleveraging, bankrupted it. Does that mean one must maintain high interest rates in India because of the existing inflation? I think not, because I think inflation here is driven by inefficient production and supply, not lack of potential for supply. Therefore, I think the way to contain inflation is to improve productivity to increase supply, not mess with interest rates, money supply, and demand (as has been seen to fail so far here). I also think that at our stage of development, India has to grow a lot (over 6% or more) to just get by. We have to grow at 8-10 percent for many years together to be able to afford to put in place the systematic infrastructure that we need to be a productive, competitive nation as a whole. I do not subscribe to any economic doctrine, such as monetary theory. Therefore, I disagree with monetarists who say that the RBI should hold rates or raise rates like Arvind Subramanian, Rajeev Malik, Ila Patnaik, Ajay Shah -not because I dont know the theory or havent applied my mind to it, but because I think doctrinaire views do not reflect the facts. I subscribe to the discipline of systematic analysis of data as in the example, and not the position: dont confuse me with the facts; this is what the theory says.

Thank you for appreciating my effort at scholarship; I think I am a serious scholar. Your poison metaphor is apt; anything in excess is a poison, and it applies perfectly to debt (too much) and interest rates (too low). However, my aim in this article was to show that the discipline of systematic evaluation through applying process-flow and decision analysis -- in this example, of financial logic -- can help make reasoned, practical decisions, whether for interest rates, or for resolving issues in power supply, or in telecommunications, spectrum and broadband. In that sense, I am not oversimplifying: I believe the RBI should cut interest rates. Best regards, Shyam Ponappa On Fri, Jul 6, 2012 at 4:30 PM, Narsimhan Srinivasan <npsrini@yahoo.com> wrote: Dear Mr Ponuppa, As i see it what started out as a very simple "aritmetical" clearcut argument regarding the appropriateness of rate cuts is now getting revealed to be a considerable oversimplification where no easy conclusions are possible. In fact you had to promptly abandon your "aritmetic" and run for shelter to ModiglianiMiller which has stood for long but is now severely critiqued for several reasons among others by Stiglitz. Lots of qualifications and yes-buts have been omitted by you. I sincerely believe that you are a serious scholar and not a Policy cheerleader? Why then were you simplifying arguments so much? To the extent of saying the case for lowering rates is a no-brainer just pure "arithemtic". Intriguing? Maybe if you had just used the metaphor of Poision which in the right doses can be a Medicine? It wouldn't have been so clearcut as your "aritmetic" metaphor but would have resulted in a closer understanding of the facts ? Best Regards Srinivasan Posted by: Akhil July 05 , 2012, 13:43 IST In our debates we should not just be talking about Growth like immature overeager schoolboys. We have to move beyond arithmetic to wisdom and start considering the dreaded possibility of "Collapse" or at least unadddressable "Disaster". One just has to look to US & Europe to understand the horrible danger of emptying one's monetary quivers in good times and being emptyhanded in cyclical downturns. When a desperate obsessive greediness prompts an addict to increase his drug dose in order to increase the intensity of pleasure. Shots start losing effect and increasingly greater doses have to be pumped in to just stay put. At that point the downward slide to hell begins. Posted by: Rajesh July 05 , 2012, 00:53 IST Hits the nail on the head. But in his timidity the writer stops short. The argument needs to be taken to its logical conclusion. If the Interest Rates are

cut by 100% the Net Profit would jump from 8.8 to 20%! The corporates would become extremely successful probably without any cost to anyone else. It is this Greenspanian easy money vision which led to the unparalleled boom of the last decade. Companies would make profits with tremendous ease and then might sit on ash as they continue to do even now in the US. How much of it will get passed on to customers and employers depends on many other competing pressures. After 'Interest', corporates can then concentrate on reducing the other major cost component Taxes Similar "arithmetical" arguments can then be brought on for reduction of Taxes as well. Posted by: SP July 05 , 2012, 15:12 IST It helps to study the domain a little before arriving at a conclusion -- e.g., the zero rate regime in Switzerland, and the contrast in Japan, the US, and the UK, versus the approach of Germany (not close to zero, better recovery), etc. Also about the balance of debt and equity -- the Modigliani-Miller Theorem, which if construed to mean that more debt that is cheaper is better, leads to the abyss, as in the collapse of Long Term Capital Management: http://en.wikipedia.org/wiki/Long-Term_Capital_Management http://www.nytimes.com/2008/09/07/business/worldbusiness/07iht07ltcm.15941880.html Posted by: Mukul July 05 , 2012, 13:59 IST Good one, Rajesh! Posted by: Rohit July 05 , 2012, 12:13 IST How smart! Why stop at zero percent interest rates. Why not go negative. Borrow Rs 100 and return only Rs 50 surely that will provide an even greater fillip to businesses. If providing fillip to businesses was the only concern of this great democracy, and if interest rate reduction has no attached price then we must go steeply negative. Even to the point of saying to businesses borrow Rs 100 and return Re 1, just as a symbollical repayment.