Can the rate cut alone stimulate growth?

Thu, 1 Oct Pre-Open

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The Reserve Bank of India (RBI) cut the benchmark repo rates in its monetary policy meeting on 29 September by 0.5%. However RBI has also slashed its output growth projections by 0.2% to 7.4%. The cut in the growth projections clearly states the poor demand scenario prevailing in the country. The current rate cut is mainly intended to provide support to the economy rather than to boost the same as the demand scenario is getting worse. This does indicate that the RBI may be worried about the current economic scenario.

There have been instances wherein the central bank has stated that the demand scenario is improving. One of their earlier reports cited instances of improvement in consumer durable production and consumer lending by banks. However, RBI stated very specifically that looking ahead the macroeconomic demand appears to be subdued.

Further, certain countries such as Brazil and Russia are already in recession. The Eurozone and Japan are struggling. The Chinese manufacturing gauge fell to the lowest in six and a half years. China's Purchasing Managers Index (PMI) came at an all time low of 47 for the month of September. The index is an indicator of the economic health of the manufacturing sector.

Global slowdown will dampen the exports from India. Back home, decline in rural consumption, shrinking pipeline of new projects, persistent capacity under-utilization, muted exports, structural weakness in the core sectors indicates the difficulty the Indian economy is going through. Probably the rate cut by the RBI has come at a time when India really needed it to support the economy.

Further, slowing inflation also provided some accommodation to the RBI to slash the interest rates. As per projections the inflation would not only be less than its 6% in January 2016 target, but moderate to around 4.8% by March 2017. Provided things move according to the estimates, RBI may still cut the interest rates sometime next year.

However, the RBI's action will be meaningless if the banks don't pass on the reduction in the interest rates to their customers. Further, rate cut will not solely be enough to stimulate the economy. Government reforms are equally important. Currently, the pace with which the reforms are moving forward is not encouraging. The government needs to fix the country's fragmented tax system, push land acquisition and labour reforms. These changes will be the key drivers of growth going forward.