Business Today

In depth: RBI rate cut will have limited impact on industry, consumers

Central bank reduces repo rate but sets inflation benchmark at 5 per cent by March 2014. Takeaway: RBI asks government to step up.

Sanjiv Shankaran        Last Updated: May 3, 2013  | 15:01 IST

Sanjiv Shankaran
The subtext of Reserve Bank of India's (RBI) monetary policy statement early on Friday is that India has exhausted easier options to boost economic growth and the central bank is no longer going to waffle in its inflating-busting mandate.

RBI Governor D Subbarao cut repo rate, the rate at which RBI lends to banks, by 25 basis points with immediate effect to bring it down to 7.25 per cent. One basis point is 0.01 per cent.

Friday's rate cut makes it the third in back-to-back policy announcements when RBI lowered interest rates. Since April 2012, the central bank has reduced policy rates by 125 basis points.

What impact has it had on lending rates for industry and consumers? Limited, says evidence. Between April 2012 and February 2013, the weighted average lending rates of banks has come down by 36 basis points to 12.17 per cent.

Transmission of RBI's signals to the end consumer is partly hampered by banks' challenges in raising cheap deposits and dealing with their bad loans.

In addition to the banking system's problems and damage to business sentiment caused by governance issues, the RBI believes 2013/14 is going to be another year of relatively slow growth.

RBI's forecast is the economy will grow 5.7 per cent in 2013/14, lower than the finance ministry's projection of a growth rate between 6.1 per cent and 6.7 per cent. The Prime Minister's Economic Advisory Council forecast the economy would grow by 6.4 per cent.

On this occasion, Subbarao has given people a good reason to believe him when he keeps saying there is limited room for monetary easing. He has set RBI an explicit inflation target for March 2014 - 5 per cent. This is lower than RBI's own forecast that inflation in 2013/14 will be around 5.5 per cent. It's another way of saying that monetary easing has reached the end of road.

Where does it leave the economy? The beleaguered United Progressive Alliance (UPA) government needs to forge a consensus among different sections of the polity - and, indeed, the broader society - to resolve tricky supply constraints in the form of land acquisition, rational pricing of electricity, and tax reforms.

Though the remit for setting interest rates in the economy may be with just one person, the RBI governor, getting all stakeholders on the same page is easier said than done. To paraphrase Subbarao: fix your system before I reduce the cost of capital.

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