When will India’s central bank (RBI) reduce interest rates?

When will India’s central bank (RBI) reduce interest rates?

Is the Reserve Bank of India’s (RBI) Governor, Raghuram Rajan, behind the curve on interest rate reduction? Some members of the technical advisory panel of RBI and a few independent analysts seem to think so.

In the September meeting, RBI’s Governor went against the recommendation of one member who wanted a repo rate cut of 50 basis points, while three others proposed a cut of 25 basis points. JP Morgan cut India’s economic growth for 2014-2015 to 5.1% from its previous target of 5.3%, citing lower than expected industrial data and high borrowing costs.

While central banks in the United States, Europe and elsewhere are worried about deflation, RBI is apprehensive about inflation. According to the minutes of the last meeting, the Governor defended his position of keeping rates unchanged by suggesting that Consumer Price Index (CPI) is still high and an immediate rate cut would have dented the inflation fighting credentials of the Central Bank.

The RBI has set a target of bringing down CPI to 8% at the start of next year and further down to 6% by January of 2016. For most of the last decade, India has experienced relentless double digit inflation.

Most economists and analysts see light at the end of the tunnel in RBI’s fight against inflation. Benefitting from the global commodity price slump, CPI for the month of September fell to a three year low. Local vegetable and fruit prices have stabilized, while rural wages and real estate prices have been muted, giving credence to the fact that softening of CPI is a trend and not just an aberration.

With experts predicting a further slide in oil prices and the International Monetary Fund forecasting a slowdown in global growth in its most recent economic outlook, worries among India’s policy makers and investors has shifted from fighting inflation to sustaining the current economic recovery.

Governor Rajan and his immediate predecessor have, at times, subtly blamed fiscal profligacy for India’s inflation woes. But that is no more the case. The newly elected Central Government has initiated several important measures in the past five months to do its part for the Indian economy. It retained the fiscal deficit target of 4.1% despite clarion calls for an upward revision by many economists and increased FDI limits in defense and insurance sectors in spite of protests by opposition parties.

Over the past few weeks, the government has freed diesel price of state control and is in the process of instituting a new system to better target subsidies. Labor reforms like single window clearance, although not far-reaching, will certainly help industry cut through the maze of pernicious labor laws. Plans are on the anvil to reduce the time for registration of a business from 27 days to just a single day.

With big victories in two important state elections and a new team in place in the finance ministry, more big bang reforms including the introduction of Goods and Services Tax (GST) are expected in the coming days that will drastically reduce fiscal deficit and perk up investor sentiment.

Now is the time for the Central Bank to act in tandem with the government for a pickup in investment. India’s investment rate was around 37% during its boom years of over 8% growth but currently hovers around 33%. Borrowing costs have been too high for too long, impeding long-term projects and there is sufficient evidence that the threat of inflation is receding.

Shale gas revolution has sent world oil prices on a terminal decline. China is likely to transition to a consumption-based economy from the current one that is driven by investments and exports. This shift is also likely to put a lid on metal and other commodity prices. On the domestic front, government is focused on increasing farm output and reforming the agriculture supply chain to contain food inflation.

Under the current scenario, economic growth risks far outweigh inflation risks. To raise investment rate, sustain the current economic recovery and boost output in the coming years, a much needed reduction in interest rate is warranted. The RBI Governor will be wise to heed the advice of his fellow panel members and lower the borrowing cost in the next meeting scheduled for the first week of December 2014.

About Author

N V Krishnakumar

N. V. Krishnakumar is an investor and ardent follower of economic and political developments in India and United States. After graduating from New York University’s Robert F. Wagner Graduate School of Public Service with a Masters in Public Finance and Policy, he returned to his hometown of Bangalore. During his time in New York, he was a consultant at the United Nations Development Program.