E-Paper
RBI rate cut: A stimulus for the economy
Whether or how effective it will be in achieving this objective is a question which cannot be answered right now. It also remains to be seen whether the central bank will continue to cut interest rates in the future.
The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has made a decision on expected lines by reducing the policy rate by 25 basis points to 6%. One basis point is one hundredth of a percentage point. The majority of economists had expected this to happen in polls conducted by Reuters and Bloomberg. Yesterday’s cut is also the first consecutive reduction in policy rates — the MPC had reduced policy rate by 25 basis points in its February meeting as well — after the MPC framework came into place. In nominal terms, 6% is the lowest policy rate under the present government. To be sure, the period from August 2017 to May 2018 also had a 6% policy rate. However, real interest rates (nominal rates adjusted for inflation) were much lower during that period. With inflation declining in the recent period, real interest rates have steadily gone up. The increase in real interest rates has come at a time when the Indian economy has been losing its growth momentum.
Yesterday’s Monetary Policy Statement categorically highlights this fact. Not only has the growth rate gone down in the last three quarters, high frequency indicators such as car sales and Index of Industrial Production (IIP) growth have also been coming down. The statement has also factored in the possibility of an adverse monsoon with the strengthening of El Nino conditions. The statement also notes that despite the favourable movement in Gross Fixed Capital Formation figures, private investment continues to be sluggish.
It is clear that the rate cut is aimed at providing some sort of a stimulus to economic activity. Whether or how effective it will be in achieving this objective is a question which cannot be answered right now. It also remains to be seen whether the central bank will continue to cut interest rates in the future. The MPC has retained its neutral stance by a majority to five against one.
The next meeting of the MPC is scheduled in the first week of June. India will have a newly-elected government in place by then. We will also have a better idea about the monsoon’s performance. It will be interesting to see whether economic players respond to the RBI’s rate cuts immediately or whether they want to hedge for clarity about election results and rainfall.
