Spooked by a falling growth and consumption, the RBI today cut interest rates for the first time in nine months reducing the repo rate and the cash reserve ratio by 0.25 percent. The central bank hopes that the two measures, when combined, will put sufficient pressure on banks to cut interest rates on EMIs for auto and home loans over the next few days in effect helping higher growth and consumption.
This is clearly good news for the consumers but may be short-lived. The bottom line is that the central bank today bowed to boost sentiment for the short term but raised enough red flags that suggest today’s rate cut may not be a long term trend.
RBI’s three big concerns right now are managing inflation, making moves that control the deficit and inducing investment into the country. “While the series of policy initiatives by the Government has boosted market sentiment, it will take some time to reverse the investment slowdown and reinvigorate growth,” said D Subbarao, RBI Governor.
India’s growth engines can restart only if we see big investment in large projects. Companies have been shy to pump money into new businesses and plants due to high capital cost, fear of policy instability around land, environment clearances and others. Government too is struggling to put enough transparent laws that give industry and foreign investors comfort in spending their capital in core long term sectors. “I don’t see today’s rate cut really boosting investment,” says Rajiv Anand, CEO of Axis Mutual Fund. “Investment will be driven by other institutional factors and changes.”
Inflation may have peaked and the RBI has forecast around 6.5 percent and 7.5 percent for next year. Economists warn that RBI reacting only to inflation based on wholesale prices – dependent on commodity prices – could be a bit misleading. It’s the Consumer Price Index which includes fuel, food prices that tends to be more volatile. But no matter which measure we take, remember any cut in interest rate fuels demand for things and that in turn shoots up inflation. In essence India will have to live with this broad range in inflation for years to come. The chief economic advisor to the Prime Minister, C Rangarajan also guards his forecast on further rate cuts by highlighting that inflation must remains on projected lines for further easing.
RBI also cited a drop in consumption across the country. Harsh Mariwala, who heads the consumer giant Marico admits to Tehelka today’s rate cut was on expected lines and will do little to move the needle on demand, and in turn reinvigorate growth.
The third and big focus is the current account deficit, which worsens with sluggishness in growth. When the GDP is already at a decade’s low, we are laden with a big current account deficit and high inflation. The slightest improvement in growth (which tends to fuel inflation by inducing buying by consumers) will only worsen this math. A record current-account deficit of $22.31 billion in the quarter ended Sept. 30 and a fiscal deficit close to 6 percent of GDP are the big constraints on easing interest rates in India in the future.