India Inc is once again clamouring for rate cuts, claiming this is the only way to revive growth. The Economic Survey too speaks at length about the risks to economic growth. Therefore it would seem there is a strong case for a 25-basis points rate cut. But in light of the Survey highlighting the need to refrain from “fiscal activism”, the RBI may do well to choose prudence over populism. Global yields have been hardening. The spread between the 10-year benchmark bonds of the US and India has been shrinking. Sudden hikes in US rates could lead to outflows from India’s bond markets, adding to the rupee’s woes.

The presumption that low interest rates will spur lending has always been too simplistic. The fact that credit growth has slipped to multi-year lows, despite lending rates falling by nearly 150 basis points since early 2015, is proof that other factors are at play. The “twin balance sheet” problem is stifling private investment and credit growth. With stressed corporates cutting back on new investments and PSBs reluctant to take on fresh risks, real credit growth is now negative, the lowest in 23 years. Unless these issues are addressed, rate cuts of a few basis points will not revive investments.

Demonetisation has accelerated the transmission of rate cuts over the past two months. While it has benefited select borrowers, it has squeezed incomes for most savers, with deposit rates plummeting over two percentage points over the past two years. India’s real interest rates — negative since 2008 — only recently stepped into positive territory. A cut in policy rate may do more harm than good if inflation creeps up with the rise in global commodity prices. India needs positive real interest rates to induce savings and push up investments. Earlier, fiscal profligacy stymied the effectiveness of the monetary policy. The RBI must stay the Centre’s course and bide its time before cutting rates.

Deputy Chief of Bureau – Research

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