The stage has been set for the Reserve Bank of India (RBI) to slash interest rates by a minimum of 50 basis points (bps) in its monetary policy review on April 5. Consumer price inflation, at 5.18 per cent year-on-year in February, is low despite two consecutive droughts. This, together with negative industrial production growth for a third straight month in January, constitutes a strong macroeconomic argument for a policy rate cut deeper than the usual 25 bps.
It has been strengthened by the budget staying the course on fiscal consolidation and not opting for “aggressive” spending policies, in RBI governor Raghuram Rajan’s words, to artificially stimulate growth. And with the US Federal Reserve clarifying last week that it is in no hurry to raise interest rates (“the stance of monetary policy remains accommodative”), there is no risk of low domestic rates triggering global fund outflows.
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But the strongest case was made by the finance ministry’s surprise move, on Friday, to bring down interest rates on small savings schemes. These cuts — from 60 bps on the public provident fund (PPF) to 130 bps on one-year time deposits — should help address the issue of what the RBI calls effective “transmission” of its monetary policy actions. Since January 2015, the RBI has cumulatively lowered its benchmark repo lending rate by 125 bps, whereas banks have not passed on even half of this to borrowers.
They argue that they cannot reduce lending rates without lowering deposit rates — which is not possible if post office schemes give higher returns. But that excuse no longer holds: Even the RBI cannot say now that there is no point in cutting repo rates when “transmission” is weak. The rationalisation of small savings rates — probably more significant than any budget announcement — will encounter political opposition, especially from those who read it as an attack on middle-class and low-income savers.
This argument is spurious at best. Savers require positive real interest rates. They did not have it when CPI inflation was in double digits and no administered savings scheme gave more than 9.5 per cent interest. But today, CPI inflation is at 5.0-5.5 per cent and the PPF rate is at 8.1 per cent — that too, tax-free — even after the latest rationalisation. The poor and middle class stand to gain much more from the boost to overall economic activity following from lower interest rates. The Modi government should stay the course here as well.