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A Rate Cut is not Enough

As was widely predicted by the market mavens, the Monetary Policy Committee (MPC) of the Reserve Bank cut the benchmark interest rate, the repo rate by 25 basis points ie. 0.25%, taking it to its lowest level in one year. The interest rate cut is due to a softening of inflation, with the inflation in February 2019, turning out to be lower than expected. The MPC however cautions that there can be an upside risk to the inflation trajectory, due to higher crude oil prices, volatility in global financial markets, a sudden reversal in prices of perishable food items and also fiscal slippages, (which are likely due to the poll promises). With consumer inflation in control and below the RBI target rate of 4%, even though the core inflation remains high at 5.3%, the MPC could focus its attention to spurring GDP growth, which is amidst a slowdown at present. As a result of the monsoon uncertainty, which significantly impacts India’s growth performance, the MPC continues to retain its policy outlook to a neutral stance.


The shift of focus/priority by the MPC in favour of growth was expected. The domestic Indian economy faces headwinds and has been slowing down. Even the MPC pruned its GDP growth estimates for the current FY from 7.4% to 7.2% and noted the fact that private investment which is a key factor to spur growth has been languishing. With the inflation rates remaining weak, the MPC had the leverage available to it, to now cut interest rates, though by a mere 25 basis points.


The reality is that the Indian GDP is showing signs of a slowdown, which is a matter of concern. From the narrow filters of a monetary policy recalibration, merely pruning interest rates is not enough to spur national growth. The first issue is to ensure that the interest rate cut is passed on by the banks to their borrowers, which they failed to do, when interest rates were cut by 25 basis points in the last meeting of the MPC held in December 2018. The second is that with GDP growth clearly showing signs of receding, an interest rate cut of 25 basis points is not enough to rekindle growth. It needs to be accompanied by an infusion of liquidity in the system, for which a similar cut in the CRR (Cash Reserve Ratio) rates was needed, which the MPC did not. The RBI perhaps thinks that the recent liquidity infusion of $ 5bn into domestic markets is enough to energise cashflows. The fact is that it is not, as is reflected in corporate profits and investment.


The next MPC meet is scheduled for June 6, 2019, by which time a new government would be in power, with its own agenda on the monetary and fiscal policy front.

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