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The Big Picture – Raghuram Rajan’s booster dose for Indian economy

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The Big Picture – Raghuram Rajan’s booster dose for Indian economy

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Summary:

The Reserve Bank of India (RBI) has cut its policy interest rate to a 4 year low of 6.75%. This is bigger-than-expected move. This move, with inflation running at record lows, could help turn around an economy that has been slowing down. It has also cut its growth forecast for the fiscal year to 7.4% from 7.6% previously, well below the government’s target of 8 to 8.5%, but still faster than China. A new inflation target of around 5% by March 2017 has also been set.

Such moves are unusual for the RBI. RBI has tended to be defensive against food price pressures after disappointing rains. Experts say economic factors probably lay behind the strong move to force banks to lower lending rates faster. While the RBI has reduced official rates by 125 basis points since embarking on an easing cycle in January, banks have moved far more slowly. This move by the rbi will give a boost to the consumer demands, particularly the housing, auto, consumer durable goods. All these sectors will give rise to the cyclic investment in real estate and several associated industries like cement, iron, steel, electrical goods etc.

These rate cuts have been motivated by a number of factors. One is the growing downside risk to global growth and trade and plummeting international commodity prices – including that of oil – which has helped bring domestic consumer prices in line with RBI targets. Subdued demand in rural markets in tandem with weakening external demand has led to significant under-utilisation of capacity and persuaded investors to hold back new investments. This has also increased the pressure on banks to pass on the benefits of rate cuts to borrowers.

There are demands for more rate cuts. Fixing structural constraints that push up inflation could be critical in determining whether the RBI considers easing policy further. While manufacturers have welcomed the rate cut, they say much more needs to be done – making it easier to buy land, a more simple tax structure and flexible labour laws, are needed to speed up corporate investments. It is also true that rate cut is good, but it alone is not a sufficient condition for companies to start investing.

Until now it was being said that the economy is not moving forward because of the RBI’s stodgy policy of stalling a rate cut because of its irrational fears of fuelling inflation. It should also be noted that the rate cut in itself is not going to have a booster effect on the economy. The banks, in turn, will have to cut their own lending rates to make it productive. The other stakeholders in the economy, including the government, the private sector and the consumers, also need to do their bit to push the economy forward.

There is a still a great deal of uncertainty about the prospects of economic growth, globally as well as at the national level. It is therefore necessary for the different stakeholders to look beyond the interest rate adjustment. Government may have to increase public spending, including the revival of stalled infrastructure projects. There is a need to assess the economy from a broader perspective. Achieving economic vibrancy is a more complicated project that requires multiple interventions and policies to make it a success.