Inflation doomed India needed high repo rate in order to reduce money supply in economy and thus helping India to control inflation.

Much awaited RBI’s bi-monthly monetary policy is out and so are the reactions on the repo rate cut. For stock market, policy has brought doomsday and Sensex fell by 660 points inspite of repo rate cut. This is first of its kind reaction of the market that inspite of fall in repo rate, market has got hammered in an unfrequented way. But that is just one part of the story.  For Indian economy, rate cut has come as a minor relief considering the fact that borrowers of capital have been working in the shadow of high cost of capital for a long time, resulting in higher cost of production and thus lower bottom-lines. For middle class, rate cut may bring some relief as Equated Monthly Installments (EMIs) are likely to fall. 

repo rate cut Reasons Why RBI Should Not Have Cut Repo Rate

What makes repo rate cut very interesting this time is the policy statement released by RBI along with rate cut. While it is routine affair, this time policy statement has called a spade a spade like never before. It won’t be unfair to say that repo rate cut hides more than what it reveals, once you read the policy statement. The macro-economic picture is not as rosy as claimed during rallies by the BJP government after completion of one year. Gloomy picture projected by the policy statement makes one wonder, ‘why did RBI cut the repo rate if macro-economic parameters requiring support of rate cut are not what they should be?’

Let us first look at inflation. RBI sounds extremely worried on inflation front. In the  policy statement RBI says, “Agricultural activity was adversely affected by unseasonal rains and hailstorms in north India during March 2015, impinging on an estimated 94 lakh hectares of area sown under the rabi crop. Reflecting this, the third advance estimates of the Ministry of Agriculture indicate a contraction in foodgrains production by more than 5 per cent in relation to the preceding year’s level. Successive estimates have been pointing to a worsening of the situation, with the damage to crops like pulses and oilseeds – where buffer foodstocks are not available in the central pool – posing an upside risk to food inflation”.  Inflation should be cut logically not just based on past data but also based on anticipated events of the future. Since the threat of inflation looms large, RBI should not have cut the repo rate.

RBI had carried out two repo rate cuts in the past. The result of the same is yet to be seen on the Indian economy. In fact, interest rate sensitivity of economic recovery is not sounding logical any more. Economic recovery has become function of policy initiative by the government and not just reduction in the interest rates. This again gets manifested in the RBI statement “Corporate sales have contracted. The disappointing earnings performance could have been worse if not for the decline in input costs. Capacity utilisation has been falling in several industries, indicative of the slack in the economy. While an upturn in capital goods production seems underway, clear evidence of a revival in investment demand will need to build on the tentative indications of unclogging of stalled investment projects, stabilising of private new investment intentions and improving sales of commercial vehicles. In April, output from core industries constituting 38 per cent of the index of industrial production declined across the board, barring coal production”. All these hurdles cannot be overcome just by rate cut for sure.  The government has to fire on all cylinders to take economy to a take off stage.

raghuram rajan Reasons Why RBI Should Not Have Cut Repo Rate

 

Additionally there are many areas where policy initiatives count more than rate cuts. RBI policy statement says that the slowdown in tourist arrivals, railway traffic and international air passenger and freight traffic could affect hotels, restaurants and some constituents of transportation services adversely. This is surely not an interest rate sensitive area and needs policy push from the government.  There is no denying the fact that credit offtake of the banks have been on the lower side, thanks to economic slowdown and availability of other options to raise funds such as commercial paper but this does not warrant a rate cut again. RBI has in recent past taken initiatives to inject liquidity in the market. As per RBI, In May, the average daily net liquidity injected through LAF fixed rate repos, besides regular 14-day variable rate repos, additional variable rate repos and MSF, was 1031 billion as compared with 819 billion in April. As a result, weighted average money market rates shadowed the policy rate.

Last but not the least, there are three future upcoming events that could derail rate cut plans and probably force a rethinking on rate cut. RBI sums this best in the policy statement, “First, some forecasters, notably the IMD, predict a below-normal southwest monsoon. Astute food management is needed to mitigate possible inflationary effects. Second, crude prices have been firming amidst considerable volatility, and geo-political risks are ever present. Third, volatility in the external environment could impact inflation. Therefore, a conservative strategy would be to wait, especially for more certainty on both the monsoon outturn as well as the effects of government responses if it turns out to be weak”. In this kind of uncertain scenario, RBI should have waited for some more time to cut the rate.

By Vivek Sharma

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