The Reserve Bank of India (RBI) on Tuesday cut its key interest rate—the repo rate-- to a five-year low of 6.5%, a move that should eventually lead to lower borrowing costs for buying houses and cars.
The 0.25 percentage point cut in the repo rate, the fifth reduction since January last year, has been primarily aided by low inflation rates that have consistently remained below the 6% mark—the red line within which the central bank wants to contain price rises.
Consumer price index (CPI)-based retail inflation, a measure of changes in shop-end prices, grew at a slower 5.18% in February, the latest for which data is available. Wholesale inflation, a marker for price movement in bulk purchases, also eased to (-)0.91% in February, the 16th straight monthly decline. The RBI reckons the price line is unlikely to raise its ugly head beyond manageable limits in the coming months.
The rate cut also comes on the back of the government’s pledge to walk the talk on fiscal discipline. A lower fiscal deficit is vital to increasing household savings and making more, and eventually cheaper, funds available for the private sector and to push investment. A high fiscal deficit—shorthand for the amount of money the government borrows to fund its expenses—can “crowd out” the private sector from the credit market by shrinking the banks’ pool of lendable resources to industry and households.
Availability of capital at low cost is critical for India’s ambitious efforts to stride ahead as the world’s fastest-growing major economy. Though India emerged from a global market-led rout in 2008 relatively unscathed, there are real dangers of the world slipping into a prolonged crisis again. That India’s merchandise exports haven’t been able to claw out of a back-to-back 15-month squeeze only reinforces the fact that the recovery will be uneven.
Given uncertain external conditions, it is essential for domestic demand to grow consistently. The RBI’s projection about 7.6% growth in 2016-17 is primarily predicated upon two factors: a pay-commission induced spurt in consumer spending, and plentiful summer rains. The reasoning goes that more cash in hand is likely to result in higher consumption by the government’s massive employee base, which accounts for a large segment of the Indian middle-class.
More demand could boost the economy through higher spending on assets, such as cars and houses. Besides, a normal monsoon after two successive drought years would boost farm incomes and push rural demand while greater supply will help keep inflation under check. With banks expected to cut lending rates soon, the bigger question, however, is whether it will prompt companies to borrow more to add capacities. There is always the risk that banks may remain awash with funds, but corporates do not borrow because of fears of muted product demand. Policy makers should stay alert on this front.