RBI rate cut is a shot in the arm for the economy

The monetary policy committee of the Reserve Bank of India (RBI), led by its Governor, Urjit Patel, has pared down the country’s prevailing nominal interest or borrowing rate. The RBI has been receptive to the viewpoint that the country’s economic attributes, on net, indicated towards such a rate cut. The trends emanating from the country’s growth rate, exchange rate, forex reserves, and average inflation level, attested to the relatively favourable circumstance for a rate cut. Furthermore, manufacturing output is somewhat flagging. This reduction of interest rate, laced with a generous dose of circumspection, should provide a requisite impetus for increased economic growth.

Monetary policy manages the change in a country’s money supply. It is within the purview of a country’s central bank. In India, the RBI is the final arbiter of monetary policy. The Union Finance Ministry essentially lays down the parameters of fiscal policy: the earnings and expenditures of the government. The RBI and the Union Finance Ministry together determine the country’s economic policy. In the past, there have been instances of difference of opinion between the authorities of the RBI and the Finance Ministry. Nevertheless, such differences have usually been papered over, sooner than later.

However, why is the monetary policy of crucial relevance regarding the possibility of increased dynamism of the Indian economy? It is because of two notable tenets of economy, which increase the scope of relevance for the RBI’s monetary policy. From 1991, India has systematically eased its FDI norms and has followed a managed floating exchange rate. Monetary policy is often a stronger determinant of economic outcome than fiscal policy.

A potential chain of events as a consequence of lowering the nominal interest rates by the RBI is scheduled to follow. There would be an increase of money supply in the economy for greater economic activity. Due to relatively high capital mobility in India, investors would remove a portion of their capital — denominated in Indian Rupee — to foreign capital markets. Consequently, there would be some pressure on the Rupee to depreciate. But, it would boost net Indian exports, ebb Indian imports than before, and lead to some improvement to the country’s current account (difference between the domestic output and national expenditure). It would propel the country’s aggregate demand than before. Ultimately, at that juncture, the country’s real Gross Domestic Product (GDP) would increase.  

RBI Governor, Urjit Patel, had been sceptical of rate cuts, earlier. In December, last year, there was high expectation that the borrowing rate would be lowered. But, Patel decided to wait for a more favourable situation to do so. Investors and the government were somewhat dissatisfied; but, could not counter the reasons for Patel’s risk aversion.

Inflation is clocking at 1.54 per cent. The country’s forex reserves come to about $386.86 billion: a strong cushion, figuratively speaking, to absorb unforeseen economic shocks, if any arise.  The exchange rate is Rs 64/$, which is less than the earlier trend toward $68/$. The GDP growth is about 7.1 per cent; faster than most other major economies of the world.

Inflation in India, at present, is at a record low; it has been further complimented by last year’s low prices, on an average, and reduced costs of most food items, internationally. The aim of the RBI is to keep inflation stable in the medium term.

Given the scenario, it has been expedient to reduce nominal interest rates now than later. Nevertheless, these trends might get reversed in the coming months. Potential leeway for economic borrowing could have become constricted. The RBI has taken care to prevent the frittering away of an opportunity for striving towards greater growth rates.

The author is an analyst, writing on international economics and world politics