In its policy meeting today, the Reserve Bank of India left interest rates unchanged for a second straight meeting.
You read it in the news, you’ve seen it on TV but the question that you are probably asking is, as a layperson, should you care?
Well of course. All macro-economic policy moves made by the central bank affects business-owners and laypeople just like you.
Let me put it in context: the central bank’s reference rate sets the tone for what commercial banks will do across the board. If the RBI raises rates, banks will raise their rates too and if it lowers interest rates, you can be sure that banks will follow suit.
The last time Governor Raghuram Rajan cut interest rates was back in September. At the time, this was a good thing to do. Lower rates mean that people and businesses can borrow at lower costs. This brings down the cost of capital for companies encouraging them to borrow more so that they can produce more. They can hire more workers, reducing unemployment and increasing wage rates.
For the individual, lower rates translate to cheaper loans from banks. It’s particularly ideal if you are looking to borrow money to buy a car or a house.
But in the lead up to today’s RBI meeting, most economists were expecting Rajan to stand pat. Sure enough, this time around, he decided to hit the pause button, just as he did in the previous meeting.
Truth be told, Rajan caught between a rock and a hard place – on one hand, a stock selloff that’s pushing the rupee toward a record low — (currently it’s at 67.93, it hit its lowest at 68.85 in 2013) and on the other, an economy that’s showing mixed signs of strength.
Perhaps the most problematic outcome of cutting rates is rising inflation, which is the one thing that has changed since his last rate cut. Back in September last year, inflation was at 4.41%. Since then, it has gradually ticked up. Consumer prices rose 5.61% year-on-year in December 2015, accelerating for the fifth straight month and reaching the highest since September 2014 (Ministry of Statistics & Program Implementation).
In the previous policy meeting Rajan indicated that he’d keep a watch on inflation vis-a-vis food and oil. And while the price of oil has certainly come down, food prices are edging up again. Food inflation was 6.4% in December, up from 6.07% in November. And central banks know it’s not a good idea to reduce interest rates if inflation is not in check.
Remember Rajan is aiming for an inflation target of 5% by 2017. Interest rates are generally inversely proportional to inflation. So lower rates may jeopardize his target if the government reneges on its pledge to narrow the budget deficit.
Anubhuti Sahay, the head of South Asia economic research at Standard Chartered in Mumbai, also points out the issue of transmission.
In fact, she sees as a more compelling argument for the timing of the rate cut: “From April 2016 we think the transmission mechanism will be better for a whole host of reasons. The commercial banks will start pricing their loans according to a new methodology and that should help the banks to pass on a greater proportion of the RBI rate cuts to the consumer.”
So what is Rajan’s next move?
Well he said today that structural reforms in the budget that “boost growth while controlling spending will create more space for monetary policy to support growth.”
Which means that he’ll wait to see what the government includes in its budget later this month and then make his decisions accordingly.