July 27, 2024

The interest rate cut by 25 basis points by the Monetary Policy Committee (MPC) in its first such decision is not surprising. There were enough indications and indicators pointing to this. When Urijit Patel spoke to the media for the first time after taking over as the RBI chief a few days ago, it was evident that he was more amenable to a rate cut that his predecessor. People said he was dovish. But they forgot that since Patel was the one who had recommended a rate policy based on inflation, he could not abandon the same.

If the MCP that he heads could lower the rates it was only because inflation targets were under control. It was also because near term outlook was also positive. It seems that for now, the negative pressure of rising inflation is over. The government has done enough to cool the price of pulses and has taken long term corrective measures in this regard. Further, with above average rainfall in nearly 85 percent of the country, kharif crop is expected to be at record levels. This will ease farm prices and is expected to keep food inflation at bay.

Given this background, the unanimous decision of the MCP to cut the rates by 25 basis points to bring it to its lowest level in six years is neither a gamble nor a bold step. It is something that needed to be done and has been done by the six wise men in the MCP. It now remains to be seen whether the rate cut spurs domestic investment or not. Given that demand for goods and services is sluggish (although it is expected to be high in the festival months due to the twin effect of 7th Pay Commission handouts and payment of bonus in most parts of the country and thereafter will be driven by higher rural demand on the back of money in hands of farmers due to good crop) and exports are not picking up, the rate cut alone will not bring in investments.

It also remains to be seen whether floundering PSU banks pass on the advantage to the consumer, leading to a fall in EMIs. The RBI has asked them to do so immediately. But in the past, banks have been reluctant to do so. Another area of concern is increasing costs of other products and services in the household basket. Even if food and fuel remain inflation negative, the cost of education, healthcare and leisure is expected to continue rising. This may have an adverse effect on the net inflation rate. But since current inflation is in check and the near term outlook is not alarming, lowering interest rate was required to boost domestic investment. This now needs to be supplemented by the government in the form of other financial reforms that will make the economy competitive.