With inflationary pressures in check, RBI should ignore anxieties related to rate cut and reduce interest rates to boost growth
Despite the best intentions and help from the Reserve Bank of India (RBI), not many banks would be able to meet the qualification to come out of preventive corrective action (PCA). The fact is that banks, which had been going through an aggressive clean-up programme in the last two years, would find it tough to come out of PCA till the time there is an improvement in economy for a sustained period. The economy is adjusting to big structural reforms like GST and growth numbers are in the process of getting stabilised. PCA is a function of how the economy is doing and this impacts the rate of recovery of these weak banks. RBI should look at growth numbers and think of monetary measures that are likely to push growth. Probably the time has come for RBI to reduce interest rates to push growth. All the macro factors required for a rate cut are clearly visible. Besides, India has probably the highest real interest rate in the emerging market space.
The central statistics office (CSO), which gave the first-ever advance GDP estimates on Monday, is expecting GDP growth to be around 7.2 per cent for FY 2019. This number is lower than 7.4 per cent which RBI gave in its estimates. Given the recent micro flashes, like auto sale numbers and credit off take, it appears that CSO has a higher probability of getting its number right as opposed to the RBI. Whenever a case is made out for employing lower interest rate as an instrument to push growth, the argument against that kind of policy stance is the fear of higher inflation. But, inflation is well under control now. Changes in the way indirect tax collection has changed is a big reason why a spike in prices due to artificial scarcity, as in previous years, is unlikely. While they might not be invoked often, anti profiteering laws will deter those in the organised sector from raising prices arbitrarily.
Another argument against an interest rate cut to boost growth is that it could trigger an outflow of debt money which could adversely impact currency value. As things stand, emerging market economies, including India, are expected to attract more money. Hot money, which was expected to move out due to developments in financial markets, has already moved out in the last twelve months. Indeed, the emerging market currency pack has probably strengthened in the last one month and this is surely a reliable indicator that there is little probability of money rushing out of India. The only risk is that money supply tends to increase at election time and this raises inflation. Lok Sabha elections are round the corner as are some important state assembly polls. So, if RBI were to wait for an opportune moment to cut rates when money in the system would not increase and push up inflation, that time might never come. In short, this is as good a time as any for RBI to think of a rate cut to aid growth.