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5 reasons why RBI needs to lower borrowing rates
The Reserve Bank of India (RBI) did not lower borrowing rates in October, contrary to India Inc and pink papers’ expectations.
The RBI’s minutes of the meeting earlier this month showed that everyone but one -- Ravindra Dholakia -- decided to keep the interest rates unchanged. Unlike the other committee members, Dholakia voted in favour of a rate reduction of 25 basis points (bps). He cited the following reasons to support his decision:
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Fuel and food inflation under control: The Consumer Price Index (CPI) and the Wholesale Price Index (WPI) are important inflation barometers. The weight of food price inflation in the CPI is 40%, while the weight of fuel and power inflation in WPI is 13.51%. Therefore, rising food and fuel prices push inflation higher.
But, Dholakia feels that food and crude oil prices are likely to remain under control. While buffer food stocks in the country can prevent food shortages this year despite monsoon deficit, crude oil prices are likely to remain stable over medium-term.
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Inflation forecast: A borrowing rate cut can lead to higher inflation. The current headline inflation, excluding the housing index, is 3%. The RBI’s forecast of inflation stands at 4.3%. This is the reason why, Dholakia argues, the central bank can accommodate a rate cut of 40 bps. The Indian Institute of Management, Ahmedabad, professor feels that even a 25 bps rate cut is too conservative an approach.
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Real interest rate: Real interest rate is the interest rate received by an investor after factoring inflation. But, the central bank’s refusal to cut borrowing rates has resulted in high real rates. This is the reason why India Inc has been averse to launching new projects in recent times, according to Dholakia. Instead, companies are investing in financial assets rather than fixed assets.
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Low capacity utilization: Capacity utilization measures the productive efficiency of an economy. India’s capacity utilisation is currently pegged at 71-72%, which suggests that the country’s productivity remains well below its potential.
Currently, the output gap is widening due to underutilisation of the labour force and physical infrastructures like airports, seaports, irrigation dams and hospitals.
Dholakia feels that a rate cut would spur the country’s productivity as India Inc would be emboldened to expand its production levels, thereby stimulating the economy.
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GDP slowdown: Dholakia’s introductory reason for lowering borrowing rates was the “significantly more than expected slowdown” in country’s growth. The “widening of the negative output gap” could be addressed by lowering borrowing rates in the country.
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Consumer confidence indicates optimism among the country’s population. The RBI conducts consumer confidence survey in Bengaluru, Chennai, Hyderabad, Kolkata, Mumbai and New Delhi. The consumer confidence index for current perception declined after demonetisation. It touched a three-year low in September 2017.
