Finally, the RBI has cut its benchmark repo or lending rate by 0.25 percentage points, even before its policy review early next month.
Moreover, Governor Raghuram Rajan has explicitly referred to a “shift” in the monetary policy stance, given a considerable easing of inflationary pressures. Consumer price inflation stood at 5 per cent in December, the third consecutive month it has ruled below the RBI’s 6 per cent target for January 2016. Besides, at least two reasons warrant a change in policy stance.
First, bank credit growth was barely 5.9 per cent during April-December, indicating very low demand for funds, justifying interest rate reductions. Second, yields on 10-year government bonds are currently around 7.7 per cent, below the RBI’s overnight repo rate of 7.75 per cent even after Thursday’s cut. A situation where 10-year money is cheaper than one-day funds is obviously not sustainable.
While the reduction in the repo rate from 8 to 7.75 per cent may itself not amount to much, it will have a significant signalling impact. The fact that the rate cut has happened outside the RBI’s policy review cycle points to further cuts in the weeks ahead: Rajan has indicated precisely this, saying “subsequent policy actions will be consistent with this [shift in] stance”. The overall message from this — that we are entering a low interest rate regime — would definitely matter for sentiment. While interest rates may not be the only factor influencing investment decisions of firms or home purchases by consumers, their ruling at double digits — well above current inflation levels — has a psychological impact. We mustn’t forget the not inconsiderable role that low interest rates had in lifting the Indian economy from its last slump during the early 2000s.
But now that the RBI has set the ball rolling on interest rates, it is for the government to play its part, ensuring that nascent sentiment at the firm and consumer levels translates into concrete investments, jobs and spending. It can no longer complain about tight monetary policy coming in the way of reviving growth. The big test of the government’s own commitment to reforms and fiscal consolidation would be in the budget in end-February. Key to this is its success in redirecting savings from wasteful current expenditures into productive capital spending and also mobilising resources through aggressive disinvestment. Such a strategy, in combination with further monetary easing by the RBI, will set the stage for the next recovery sooner rather than later.