Reserve Bank of India Governor Raghuram Rajan’s decision to cut the rate at which it lends to commercial banks was not unexpected, though decisions on interest rates outside the policy cycle are considered unusual. The RBI move comes over two weeks ahead of the next review meeting slated for February 3.
The declining inflation is seen as the main influence behind the decision – the rate has been falling consistently for some months now. The RBI’s preferred consumer price inflation was 4.4 per cent in November and 5 per cent in December against its accepted target of 8 per cent for January, 2015. But the governor’s statement that further reductions in rate cut would depend on both the decline of inflation as well as fiscal consolidation points to the difficult course which lies ahead for RBI as well as the Centre.
As regards positives from the RBI move, the global decline in crude oil as well as commodity prices should help the government reduce current account and fiscal deficits. In the latest Global Economic Prospects report by the World Bank, India and the US are the exceptions among the major global economies whose growth rate has been revised upwards. Indeed, it even sees India outsmarting China and becoming the fastest growing major economy at 7 per cent GDP growth by 2017-18 and expects the decline in crude oil prices to hold for the year. Already India’s trade deficit is at its lowest point in 10 months at $9.6 billion in December driven by the fall in crude prices. The RBI has given a definite signal that it has a downward bias in rates. Consumer, vehicle and housing loans are expected to come down, but Indian banks are constrained by their difficult loan books from fully passing on the benefits to customers. So, while the rate cut with its expectations for further reductions are encouraging, for the economy to truly fire on all cylinders, the investment cycle has to revive. There’s little doubt that the debt-laden private sector cannot revive on its own without government initiatives.
The government had wanted the RBI to reduce the repo rates. The move has made Finance Minister Arun Jaitley happy and he has welcomed the interest rate reduction as a positive development while noting that it would lead to more money in the hands of consumers resulting in greater spending. There is also hope that the decision will help revive the investment cycle that the government seeks to restore. The road map for this revival is expected from the Union budget.
