Breaking News

Interest rate reduction is justifiable

By DM Deshpande


The RBI in its quarterly monetary policy review announced the reduction in repo rate by 25 basis points. The new repo rate is six per cent. Interest rate is one. Yet it means different things to different persons. For someone in business this would mean the cost at which he/she will be able to borrow money. To a person who has invested in fixed deposit, interest rate will mean the earnings on the principle sum. To an expert, or fund manager or a bank manager in charge of treasury operations, it will mean the yield on government bonds. The interest rate for a policy maker like say RBI, is a signal that is being sent out to market and other stakeholders about the financial health and direction of the economy.

Lower rates is a good news for borrowers but it is not so for savers. Generally speaking, lower interest rates are better than high rates for the overall well being of an economy. Lower rates, by reducing the cost of borrowing, encourage the business and industry to borrow more, invest, produce and enhance capacities. At lower rates, demand for loans is higher and with easier credit terms, there is spurt in buying. This in turn will mean more jobs and incomes, a sort of virtuous circle.

On the other hand, with higher rates, cost of borrowing goes up, so also the prices of goods and services. Costly money means less borrowers and lesser demand. World economy, especially the developed west, is showing signs of sluggishness and therefore central banks are lowering rates.

The RBI has lowered its growth forecast for the current fiscal, albeit marginally from earlier 7.4 per cent to 7.2 per cent. It has also maintained that this is lower than the potential of the economy. While doubts persist regarding official growth figures, the trend is unmistakable and clearly it points upwards. Notwithstanding a certain sluggishness in the global economy, the RBI does not expect any further loss of growth momentum in Indian economy. On the contrary, it expects a certain uptick going forward in 2019-2020. The RBI is not wrong as its optimism has a basis in facts.

One, capacity utilization was refusing to move up in the last few years; now within three months up to December last year, in manufacturing it has gone up from 72 per cent to 76 per cent.  Second, rate of inflation has remained subdued, with headline inflation remaining well within the four per cent target set by RBI continuously for seven months. Further the RBI has lowered  inflation forecast for the year, which is an indication that further cuts in rates are possible through the year. It is another matter that the core inflation, that is not taking in to account food and fuel, has been sticky at more than 5 per cent. But this could also be interpreted as a sign that the demand in the economy is picking up.

And third, perhaps the strongest factor on which growth depends is fixed capital formation. This has risen steadily in the last seven quarters; it’s ratio to GDP had plunged to below 30 per cent in the last five years. Considering that, this is remarkable turnaround. Still, till such time that the capacity utilization does not cross 80 per cent the government will have to play an active role in investing in infrastructure directly or through the PPP route.

Two other measures announced are commendable. One, appointment of a task force to suggest measures to develop secondary market for corporate bonds. Several companies have come out with bond issues but through the mode of private placements. A SEBI rule requires that large corporates will have to borrow at least 25 per cent of their requirements by issuing bonds from 1st. April 2019 and not depend entirely on bank loans.  A vibrant secondary market for bonds will help in developing the capital markets in the right direction, with the economy poised for huge growth in


Second, announcement of a committee that will go in to issues relating to greater securitization of mortgages. These measures are more important than a mere cut in repo rate. After all, the transmission mechanism, that is translating the RBI’s rate cut in to actually reducing interest rates on borrowings has been weak. There is simply too much rigidity in the Indian credit market.


*The writer is in the field of higher education- teaching, research and administration for nearly four decades. Presently he is the Vice Chancellor of ISBM University, Chattisgarh.

Check Also

Insurance or no insurance for COVID-19?

By Tensing Rodrigues Should you cover yourself against COVID-19 or not ? Does it sound …