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Inside a macroeconomic trapeze

RBI kept its lending rates unchanged on Monday. Hours later US credit rating firm Fitch downgraded India’s outlook to ‘negative’. HT explains how prices, interest rates and investor sentiments are linked

business Updated: Jun 19, 2012 20:42 IST
Gaurav Choudhury

What has the RBI done?
The Reserve Bank of India (RBI) has kept the repo rate — the rate at which it lends to banks — unchanged at 8%. It also kept the cash reserve ratio (CRR) — the proportion of deposits banks have to park with the RBI — unchanged at 4.75%.

What would have been the impact of a CRR cut?
The CRR is the proportion of deposits banks have to park with the central bank. A 0.25 percentage point cut in CRR cut would have made about Rs 16,000 crore additional funds available with banks to lend to companies.

What about the repo rate?
The repo rate is the rate at which the RBI lends to banks. A lower repo pushes down banks’ borrowing costs prompting them to reduce interest rates for final home, auto and corporate borrowers.

How does a cut in the reverse repo play out in the economy?
The reverse repo rate is the rate at which RBI sucks out money from banks. A lower reverse repo discourages banks to park money with RBI and lend to individuals and firms from where they can earn more.

What does it mean for you?
The RBI’s action, or the lack of it, would imply that if you are an existing home loan borrower, don’t expect your equated monthly installments (EMIs) to come down soon.

Why has RBI maintained status quo?
The RBI’s decision to keep its lending rates unchanged has stunned business leaders and economists, many of whom had expected the central bank to cut rates to counter a crippling industrial slowdown. The RBI has made it clear that a cut in interest rates will fan inflation that is racing towards uncomfortable levels, despite a worrying slowdown in the broader economy.

Can you explain the linkage between growth, interest rates and inflation?
When growth falls, it is usually expected that the central bank cut interest rates to boost demand and spending. The RBI, however, argued that people’s higher purchase of goods prompted by lower interest rates will only help push up prices at this point.

What has led to lower growth?
Growth of India’s gross domestic product (GDP) — the total value of all goods and services produced within the country — has fallen to a 9-year low of 5.3% during January to March 2012 hit by an industrial slowdown. Industrial output crawled at 0.1% in April and business leaders have blamed high borrowing and raw material costs for slowing investment. They say that companies have deferred capacity expansion plans as cost of raising capital has jumped sharply in the last two years. RBI, however, said that the real effective bank interest rates are still lower than 2003 and 2008 — the period in which India’s GDP was growing the fastest. So, it may not be correct to blame high interest rates alone for slowing investment.

What has Fitch Ratings said about the Indian economy?
RBI’s status quo on interest rates, which rattled stock markets and disappointed industry, came hours before the US credit rating agency Fitch Ratings downgraded India’s credit outlook from stable to negative, warning that growth could deteriorate if immediate reforms measures weren’t initiated.

Why has Fitch made such comments?
The agency has blamed slowing reforms for its adverse comments on the Indian economy. India, it said, faces an awkward combination of slowing growth and still-elevated inflation. According to Ftich, India also faces structural challenges surrounding its investment climate in the form of corruption and inadequate economic reforms

What were the other international agencies commented adversely about India in recent months?
In April, Standard and Poor’s (S&P), another US credit rating firm, had downgraded India’s credit outlook to negative. Last week, it warned that India could be the first of the BRIC (Brazil, Russia, India, China) to lose its investment-grade rating unless it pushes reforms. Moody’s Analytics, an arm of credit rating agency Moody’s, last week said India’s economy is in stagflation.