The Reserve Bank of India on Wednesday decided to cut its benchmark policy rates by 25 basis points to 6% from 6.25%, as expected by a majority of economists.
The six-member Monetary Policy Committee voted 4-2 in favour of the rate cut, which now leaves the reverse repo at 5.75% instead of 6%. While one member had proposed a larger 50 basis points cut, another voted in favour of status quo.
The MPC believes that there is an urgent need to reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to the Pradhan Mantri Awas Yojana for people’s housing needs.
The RBI rates
One basis point is one-hundredth of a percentage point. The repo rate is the rate at which the RBI provides funds to banks. A cut in the rate implies cheaper credit for banks, which, in turn, are expected to lower the cost of loans for their customers.
The committee has a mandate to keep inflation below 4% with a 2% room on either side of the target to manage growth and other policy expectations. However, consumer price inflation, which is now the benchmark for the central bank to measure prices, has been falling steadily – it dropped from 3.81% in March this year to 1.54% in June.
The RBI had last cut rates in October 2016, when it brought the repo rate down to 6.25% from 6.5%. In February, however, it had surprised many by moving its stance on monetary policy from “accomodative” to “neutral” without changing the rates.
An accomodative stance implies that the central bank sees legroom to cut interest rates, whereas a neutral stance implies that there is lesser clarity on how the economic conditions will shape up and that a decision on rates will be made depending on data received.
Moreover, the RBI has a dual mandate to keep inflation in check while enabling growth in the economy. While inflation indicators seem to show positive signs, growth is nowhere near the levels expected as bank credit slipped to a 60-year historic low earlier this year, displaying a continued slowdown in the industry.
This becomes important as private investment has yet to pick up in light of excess capacity with companies. Capacity utilisation is still hovering around 75%, according to RBI data, and investments, and subsequently credit, tend to pick up when it breaches the 80% mark.
Meanwhile, demonetisation did result in some slowdown in the Indian economy. The GDP growth for 2016-17 was 7.1%, as the last quarter of the financial year saw a growth of only 6.1% compared to 7% in the previous quarter. The economy had grown at 8% in 2015-16, according to the government’s revised estimates.