In a bid to kick start economic growth, India's Central Bank has aggressively cut interest rates on September 29, 2015. The reduction repo rate, the level at which Reserve Bank of India (RBI) lends to commercial banks, is down from 7.25% to 6.75%. This has come as a big pleasant surprise to the market which had expected only a 25 basis-points (bps) reduction.
Economists though were expecting a cut since a long time, but a somewhat cautious reduction. But the whopping 50 bps reduction means, that the repo rates are at its lowest since March 2011. The rate cut following a sharp drop in inflation, is expected to spur investment and growth in India.
In a lighter note, the RBI governor, Mr. Raghuram Rajan said, “I don't know what you want to call me... Santa Claus... you want to call me hawk, I don't know. I don't go by this. My name is Raghuram Rajan and I do what I do". He was responding to the comments that he was being a ‘Santa Claus’ in cutting interest rate by more than expected. Raghuram Rajan, is a globally renowned economist, famous for correctly pointing out the prevailing risks in the global financial system back in the mid 2000s.
Announcing the half yearly policy, the RBI governor further said, "Reserve Bank's stance will continue to be accommodative, the focus of monetary action for the near term will shift to working with the Government to ensure that impediments to banks passing on the bulk of the cumulative 125 basis points cut in the policy rate are removed. The Reserve Bank will continue to be vigilant for signs that monetary policy adjustments are needed to keep the economy on the target disinflationary path."
Importantly, the interest rates have significantly high influence on both growth and inflation of any country. Lower interest rate, means higher is the supply of money in the economy and greater is the purchasing power of the individuals. Any improbability of this variable only amplifies the overall uncertainty in which investment decisions have to be made. Higher interest rate translates to high cost of the capital and contributes to slowdown of the investment in any economy. High interest rates also have an adverse impact on FDI. In Indian condition, it was RBI maintaining a balance between these two factors which runs the economy. RBI’s interest rate policy is to assist the anchor expectations and reduce uncertainty.
Hours after Rajan's bigger-than-expected rate cut announcement, India's largest bank, State Bank of India (SBI) reciprocated with a 40 bps cut in its base rate effective from October 5. The SBI will now peg its base rate at 9.30%. Other lenders are also expected to follow suit soon after the RBI’s sharp repo rate reductions.
With the inflation well under control this strategic initiative is likely to increase the public investment, push the banks to increase lending and finally, over time, accelerate corporate profits by increasing stock prices. This development is a step ahead in more collaborative working approach between RBI and the Government towards fiscal policies.
This move, designed to provide a boost to consumers and the economy, is immediately welcomed by Indian Prime Minister Narendra Modi's business-friendly NDA government. Policymakers, including the Indian Finance Minister Mr. Arun Jaitley have said that the transmission of RBI rate reductions by banks will boost investments. Importantly, in the run-up to the 2014 General elections, Mr. Modi has promised “Acche Din” (Prosperous Future) to his voters and the people of India, and since the inception of the present Modi government in May 2014, people were eagerly waiting for such land-marking decisions on ground. This move, though not taken by the government, can be considered to be a significant step in that (desired) direction.