Rate cut good for you but bad for the economy? | Shaili Chopra

Rate cut good for you but bad for the economy?

RBI Governor D Subbarao

RBI Governor D Subbarao

Will the RBI cut interest rates? That’s the million-dollar question just 24 hours before the first credit policy of 2013 is tabled. The central bank is expected to cut repo rates for the first time in nine months; a move that may unstick the machines of the consumption economy and bring brief relief to high interest costs for corporate India.

All this may only be possible if RBI’s potential rate cut actually translates into an interest rate cut by bank for its customers. Just last week, the central bank governor D Subbarao said inflation remained too high, a comment that sunk market hopes of a 50 bps rate cut. Research houses had to quickly redo expectations and as of today –as gauged by a Reuters poll – RBI may cut repo rates only by 25 bps bringing it to 7.75%. The rate at which the RBI lends money to commercial banks is called repo rate. There is plenty of speculation that banks may not immediately pass this on unless there is an unwritten diktat from the finance ministry to do so.
The issue to address is really whether a rate cut right now can spur growth, bring back confidence and adjust with a reasonably high inflation rate.
A 25 basis point rate cut can further spark the small revival already seen in industrial activity if passed on. Chambers FICCI, CII have suggested a rate cut at this hour may be the ‘much needed oxygen’ for growth. India Inc too has cited the desperate need for capital costs to ease.  This is because corporations in India have no other means at the moment to lift off pressure. Global investments into businesses are slowing, cost of funding is up and sales in general are volatile as consumer pockets are constrained due to high rates. It’s a bit of a vicious cycle and so any rate cut – the first in nine months- will be considered a pain reliever.
As per the December figures, the Wholesale price inflation or WPI, the main price measure, is down to a three-year low but still remains above 7 percent. The retail inflation figure is far scarier at over 10%. Rising food prices is a big concern and so it’s fair to assume any marginal let up in inflation is often due to a seasonal turn in prices of fruit, vegetables and other such items. Inflation still remains a material problem for the RBI.
 
A rate cut at best can be considered a short-term booster shot but not a long term solution to India’s growth challenges. For the GDP to return to 9 per cent plus growth, we need investment, infrastructure and industrial activity. For investments to happen, it’s nearly impossible that domestic savings alone fund it. As a result foreign money is a must for infrastructure, high-capital assets to be built. Hopefully the recent reforms will bring in more currency but one cannot be sure if that alone will be sustainable. Recent FDI data shows
inflows declined to a nearly two—year low of $1.05 billion in for Apr-Nov 2012, mainly due to global economic uncertainties. In November 2011, the country had attracted FDI worth $2.53 billion.
It’s safe to say that rising interest rates sliced away India’s economic growth rate between the first quarter of 2010 and the third quarter of 2012. The Indian economy grew by 5.4 per cent in the first half (April-September) of the current fiscal, against 7.3 per cent in the corresponding period last year.
A rate cut at this stage may change the mood of the nation but cannot be instrumental in fixing its deep-rooted problems. And so is it prudent to live with the notion that a rate cut on Tuesday may be a one-off and not the beginning of a trend?

(The views expressed in this column are the writer’s own)

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