RBI cuts repo rate by 25 bps: Industry gets what it wanted but households stand to lose again

The decision to lower rates, though expected by the market by an even larger magnitude, is a bit surprising considering that the factors that had held the Reserve Bank of India (RBI) back in June are probably still nebulous today. If one looks at the possible impact of goods and service tax (GST) or even the house rent allowance ( HRA) component in the consumer price index (CPI) on overall inflation, it is still unclear. Also, these numbers are not out as yet and will manifest only with a lag well after July

This move is good for industry which has been looking for such rate cuts. But will it help? Here the answer is a shoulder shrug because with excess capacity and low demand conditions industry is unlikely to invest more in machinery. Hence lower rates transmitted through the  marginal cost of funds based lending rate (MCLR) would improve profitability though not necessarily bring about growth.

There would, however, be expectations that the RBI will oblige again in October as food prices should be moderated with a good kharif harvest and come down further. Hence the market will expect another cut in October for sure.

But what about households? This is not good news because of two reasons. First, lower returns on deposits has already been triggered by State Bank of India (SBI) on savings deposits and this is a big blow considering that so far banks have been lowering term deposit rates but kept the savings rate unchanged. This will definitely lead to an overall reduction in rates which will impact the fixed income families, which are increasing in numbers. In fact, other public sector banks (PSBs) may be expected to lower their savings bank rates soon.

Second, the inflation data interpretation will not find favour with the household which have seen prices of food, especially vegetables, increasing sharply. As policy makers look at changes in price indices on a year-on-year basis and households look at it from a month-on-month basis, there will be less conviction that inflation has really come down.



Are interest rate cuts adequate to drive the economy? The answer is definitely ‘no’ as it has to be backed by some fiscal measures in terms of expenditure which unfortunately has not been forthcoming as governments are busy adhering to fiscal targets. In fact, this year, with the UDAY bonds interest commitment as well as loan waivers being invoked, there could be major slippages in capex of states.

The focus so far has been only on monetary policy to bring about growth which is erroneous. Nowhere in the world has growth taken place with just monetary action, and there needs to be a push on the demand side too. The USA case is quite glaring here where the economy is still to recover fully ten years after the financial crisis notwithstanding bringing down rates to close to zero and pump-priming through purchase of securities in the market through what was called quantitative easing programmes.

Can there be a negative impact on the economy? It has been observed that the financial savings rate has been coming down in the country as interest rates have declined. There will be an incentive to channel funds into real estate and gold. Also, with the recent boom in the equity markets due to irrational exuberance, there would be a strong temptation to invest in such instruments as it gives better returns or promises the same. This can make households vulnerable once there is a correction. Interestingly, with SBI lowering interest rates on savings bank accounts, there is an advantage in investing in the ultra-short term funds which give post-tax returns of between 4.5-5 percent today! At any rate one can expect some changes in the savings pattern of households in the months to come.

Quite clearly it can be seen that banks would be very keen to cut costs wherever possible to improve their profit lines while addressing their non performing assets (NPAs). Demonetisation has generated too much money in the form of deposits for banks to the extent that it has become a burden as they have to be perforce invested in reverse repo operations of the RBI. They would be happy to see deposits growth slowdown. Hence, this measure is good for them and they could be counted as gainers from the rate cut.


Loknath Das

Loknath Das

I am a blogger with the main motive of writing articles at my choice of level. I do love to write articles and keep my website updated regularly , if you love my article then be sure to share with your friends as they would love to read my article...

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