Home >Opinion >Quick Edit >Good news: RBI has defied rate-cut expectations
India's central bank has wisely held its main policy rate at 4% (REUTERS)
India's central bank has wisely held its main policy rate at 4% (REUTERS)

Good news: RBI has defied rate-cut expectations

  • Though a rate cut was what many bankers expected, the central bank’s decision to leave its repo rate unchanged at 4% is spot on. Real interest rates must not be driven deeper into the negative zone

It was a tough rate call for the Reserve Bank of India (RBI), with weak growth impulses and high inflation pulling its decision in opposite directions. The latter seems to have prevailed. RBI on Thursday left its repo rate unchanged at 4%. This is the rate at which it lends overnight funds to commercial banks, a rate that has already been slashed by a cumulative 115 basis points since February, and that too after 135 basis points of easing last year.

RBI’s rejection of demands for a 25 basis points cut is backed by a sound rationale. Average inflation has remained above the 6% upper bound of its target range for two consecutive quarters. While easier money may or may not have stoked prices up, the repo rate is already in the negative zone in real terms. Indeed, a rate cut at this juncture would have been little more than tokenism. That’s because it isn’t the cost of money that has held investment and private spending back, but prolonged economic uncertainty and a collapse in demand caused by the corona crisis. Unless demand picks up, cheaper loans won’t help much—if at all banks overcome their risk aversion and lend. They have enough money to lend. And demand for loans isn’t too strong either. This is reflected in the cash available in the banking system. Banks have been parking as much as 7 trillion with the central bank under its reverse repo liquidity window.

Pushing rates further down could put off savers in India, many of whom rely on bank deposits not to lose value to the corrosive effect of inflation on the rupee’s purchasing power. What people withdraw from their accounts is already worth less than the money they put it. Why worsen it? Savers often do not track the ups and downs of inflation, and don’t mind losing some money to it, but if RBI’s policy rate falls below the central point of its inflation target of 4%, then it would suggest that it’s okay with such financial repression. With the economy contracting and incomes crunched, savers may respond by moving money into risky investments. On a large scale, that would spell its own hazards. A long period of negative returns on bank savings could distort incentives across the economy and result in misallocation of capital. It’s best to keep the repo no lower than RBI’s inflation target. The risks outweigh the benefits.

Subscribe to Mint Newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.

Click here to read the Mint ePapermint is now on Telegram. Join mint channel in your Telegram and stay updated

Close
×
My Reads Redeem a Gift Card Logout