Economists divided on RBI rate cut demand

With just a few days left for the next policy review by Governor Raghuram Rajan, lobbying by India Inc for lowering the interest rates has touched a crescendo, particularly after CPI inflation trended lower at 3.66 per cent in August and the US Fed deciding to stay pat.

Top economists have mixed views on this demand. Some agree that a rate cut will help, while some others urge Rajan not to relent. SS Tarapore, Economist and former Deputy Governor, RBI, warned in an article in this paper that a further reduction in interest rates will result in a major shift from financial to physical savings. Rajan himself had made this point at the FIBAC conference in Mumbai last month when he said that the silent majority of depositors had shifted to gold and real estate when interest rates did not compensate for the level of inflation.

Crucial policy signal DK Joshi, Chief Economist, Crisil, didn’t think the Fed move to stand pat makes the job for Governor Rajan any easier. But the possibility of no volatility for the next two months opens up a window for the RBI. He said the RBI cannot perpetually wait for the Fed to make the first move. He expects the Fed to act in December. He feels that a 25 bps cut will be a crucial policy signal from the central bank.

TB Kapali, Financial Consultant, differed with those advocating a cut and said that the real villain for a range of current problems is the cheap money floating in the system.

Urging Rajan not to cut rates, he argued that India Inc’s demand for a cut is a bit ironical when the impact of the rupee’s slide from 45 to 65 a dollar levels is far higher on corporate balance sheets than a 25 bps cut that they are demanding. He said that the cost of servicing foreign debt that India Inc raised liberally during the past few years has actually doubled because of the exchange depreciation.

Inflation target Shubhada Rao, Chief Economist, YES Bank, said that the Fed’s status quo was in sync with Governor Rajan’s recommendations and would give time for market sentiments to adjust. She feels, CPI inflation is likely to undershoot the RBI’s January 2016 target of 6 per cent by 50 bps and has opened up space for an incremental 25 bps easing next week.

Rao disagrees with the contention that 75 bps of monetary easing has done nothing so far. She says, “Money market rates for CPs and CDs have responded commensurately and is already providing comfort to credit markets. For the banking system, monetary transmission works through with long lags (two to four quarters).”

She said banks will lower their rates further in the coming quarters.

She maintained that the process of putting India Inc in order has, in fact, begun. Going forward, lowering inflation, project clearances and stepping up of government capex will have significant positive effect. Greenfield investment activity is expected to pick up only from the second half of FY17, she said. 

COMMENT NOW