Given that inflation is touching an all time low, the monetary policy committee (MPC) has changed its stance to neutral from calibrated tightening and lowered the repo rate by 25 basis points. The sixth bi-monthly meeting of RBI, chaired by the newly appointed governor Shaktikanta Das, unanimously voted for reducing the repo rate. The cost of capital is going to be low because the banks will reduce loan rates as a consequence of the RBI’s decision to reduce repo rate.
India has one of the highest ‘effective lending rates’ in the world. As the central banks around the world are flooding the economy with cheap capital, the Reserve Bank of India has kept lending rates high. The central bank has taken a ‘very conservative’ stance of monetary policy and this hurt the economic growth of the country. The unavailability of cheap capital stalls economic activity and hurts economic growth.
Economists like Surjit Bhalla are against the central government behaving in a hawkish manner on inflation data. The criticism mainly comes on the basis of how the RBI decides the ‘core’ inflation data. RBI’s definition of core is, excluding food and fuel. But in India, petrol (what is considered fuel in most parts of the world, and not the price of kerosene or electricity) is part of transport and communications. The former governor of RBI Raghuram Rajan also pointed this out many a time.
The drop in repo rate will have a serious implication on the day to day life of ordinary civilians, because this rate decides the rate of interest at which people and companies will get loans from the banks. With this, all types of loans like home loans, personal loans and car loans will be cheaper. The banks and Housing Finance Companies such as the State Bank of India, HDFC, ICICI Bank, PNB, Bank of Baroda, UBI, and the Kotak Mahindra Bank are expected to reduce lending rates in the upcoming days.
The previous RBI governors, Urjit Patel and RaghuramRajan have taken a conservative stance on repo rates. RBI is considered one of the most conservative central banks in the world as it keeps the cost of capital very high compared to other developing and developed countries. This has led to a tussle between the finance ministry and RBI. The interest rates always create a tussle between the central bank and government in every country in the world. There was a period in the United States known as the Greenspan era (1987-2006) when the government and central banks kept the interest rates low for the economic growth of the country. The government expects dovish interest rates for economic growth and the central bank argues for hawkish interest rates to combat inflation.
The lower cost of capital will propel economic growth in the country as economic activity will increase due to cheap loans. The central bank has enough space for reducing interest rates and inflation under the Modi government touched a new low of 2.19 percent in the month of December. The floor set for inflation is 2 percent and ceiling is 6 percent, as inflation is moving towards the floor, a lower interest rate was necessary to propel economic growth.
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