On headroom for rate cuts, RBI in enviable position

Most other economies do not have the rate cut option as their rates are low, and inflation is high.

By: ENS Economic Bureau | Badaun/new Delhi | Published:January 16, 2015 2:32 am

With the RBI’s impromptu 25 basis points cut in policy rates on Thursday marking the beginning of what could be an extended rate cut cycle, India finds itself in a position of strength vis-a-vis other major economies in terms of having substantial headroom to loosen its monetary stance to stoke growth.

Most other economies, with the exception of China, are constrained in terms of not having the option of cutting policy rates to kickstart growth, either because their rates are already low or they need to tighten rates further to counter spiralling inflation.

As the prospect of a wobbly recovery in the global economy unfolds in 2015, alongside the possibility of a gradual inching up of oil prices as the year advances, that India’s inflation is likely to stay benign on account of the base effect for a majority of the year is likely to spur this rate cut cycle.

Cuts in policy rates prompt banks to lower lending rates, enabling industry and consumers to borrow more, thereby boosting both investments and consumption.

Other major developing economies, including Mexico, Russia and South Africa, are not in a position to cut rates on account of domestic compulsions (See chart alongside).

The World Bank Group’s Global Economic Prospects (GEP) report released on Wednesday did point the possibility of financial market volatility in 2015 as “interest rates in major economies rise on varying timelines” though the year.

Leading the pack is the US, where the Federal Reserve is expected to start gradually nudging interest rates higher later this year. The Bank of Mexico is expected to follow the Fed’s lead while the Central Bank of Brazil is expected to continue a campaign of interest rate increases that has already taken rates from 7.25 per cent to near 12 per cent since April 2013.

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