It is now time for an RBI rate cut

It is now time for an RBI rate cut

Context:

The caution displayed by the Reserve Bank of India’s (RBI’s) monetary policy committee regarding inflation has come under a lot of criticism

Introduction:

• There is a compelling case for the monetary policy committee to cut interest rates.
• Monetary policy has had to be asymmetrical to quell the persistent inflationary fire.

What could possibly thwart RBI from cutting the policy rate?

• RBI’s arguments that a lack of transmission in the banking sector due to the stockpile of bad loans makes it futile to cut rates.
• Real interest rates have surged because of the inflation fall and HSBC estimates that present real interest rates give RBI room to cut by as much as 75 basis points.
• Even towards the June meeting, inflation had decelerated sharply; private investment was showing no signs of pick-up and oil prices also seemed at structurally low levels.

Present situation

• The recent decline inflation appears to be structural in nature, as is evident from the trend in headline inflation, core inflation and inflation expectations.
• According to HSBC economists the inflation differential between India and the rest of the world has narrowed on a sustainable basis.
• Disinflation is the result of a combination of factors like prudent monetary policy, modest increase in minimum support prices and the downturn in the global commodities cycle.

Criticisms:

The caution displayed by the Reserve Bank of India (RBI) in recent months has come under a lot of criticisms

• It is worth bringing an important principle in monetary policy into the public debate at this juncture.
• The Indian central bank would have erred in rushing into a hasty rate cut when faced with multiple uncertainties and multiple exogenous shocks over the last few quarters.
• The transition to the new goods and services (GST) seems to be a smooth affair.
• The US Federal Reserve may go slower than expected when it comes to whittling down its bloated balance sheet.
• The monetary policy agreement explicitly says the Indian central bank would have failed to meet its target only if inflation stays outside the accepted range for three quarters in a row, rather than any single month.
• Most private sector forecasts over the next 12 months seem to suggest that inflation will be a little above 4% a year down the line, or very close to the central point of the inflation target.
• These inflation forecasts serve as the intermediate target of Indian monetary policy, given that changes in interest rates affect the real economy with a lag of around three quarters.
• Long gap between the inflation expectations of Indian citizens and the inflation target of the RBI. This indicates that the credibility of the Indian central bank suffered because of years of high inflation.

Conclusion:

India has entered a welcome stage of macroeconomic stability because of prudent policies over the past few years. Sustainable economic growth comes against the backdrop of such stability and economic reforms.