The Reserve Bank of India, the country’s central bank recently decided on taking a breather and put its rate-cutting spree on hold by keeping the repo rate (i.e., the rate at which RBI lends money to private banks) unchanged, but only after five consecutive (stock market-pleasing) rate cuts.
By reducing rates, RBI hopes banks would borrow more from it, and pass the money along to borrowers at lower rates, thus kickstarting consumption and investment spending (for instance, the common man taking more auto loans, or the industry taking loans to invest in new factories, as interest costs come down) and by extension, economic growth (which comprises, amongst others, consumption and investment expenditure).
So how can we understand the RBI rate cuts in their proper context? India’s recent growth data (4.5%, a six-year low in July-September 2019) suggests that India is not able to keep pace with its fastest-growing large economy crown. However, all is not lost: according to the Asian Development Bank, recent government measures such as the corporate tax cuts mean India’s economic growth could rebound to more than 7% next year.
So how do policymakers usually respond to such instances of slow growth? By using two broad levers: fiscal and monetary policy. The former can be thought of as the government spending more on infrastructure, for instance, thus boosting employment and spending, while the latter consists of mainly the central bank’s control of benchmark interest rates. However, in India’s case, the government itself is struggling to expand its spending (recent tax collections have come in considerably below expectations, and there is a limit to its borrowing capacity too), which is why, the ball is in RBI’s court now. This also takes us back to why the pause in the rate-cutting spree assumes a lot of importance, particularly when market participants were expecting yet another rate cut.
While the RBI is responsible for spearheading the growth, it is (rightly) balanced in its policy approach: too much inflation is a no-no (a lot of growth propped up by interest rate cuts can result in prices rising rapidly, and the economy coming to a halt), which might be one of the many reasons why the RBI decided to pause its rate cuts and wait for more clarity on the growth-inflation dynamics going forward.