RBI’s rate cuts alone are not going to work
The latest reduction by the Reserve Bank of India in the short-term lending rates is not going to help the common man because the banks are unlikely to pass on the benefits to consumers who have taken loans for the purchase of moveable or immoveable products. The equated monthly instalments are largely going to remain unchanged from the present. This is primarily because the banks believe that the cut is not adequate enough to cover their costs if they pass on the benefits to the consumers. Yet, this being the third such reduction by the RBI in four months, it provides a glimmer of hope that the drop in interest rates can get more substantial in the coming months. But that hope rests on how well the Union Government manages its finances. Inflation is still at an uncomfortably high level and the pinch is evident in the pattern of consumer spending over the last months. For instance, automobile sales — which are as good an indication as any of an economy on the move — slumped seven per cent in April. People are generally reluctant to spend as much as they would like to because the interest rates are high. Because of inflation and high interest rates, there has been erosion in disposable incomes. The key to a reversal of the trend lies in higher growth. But that's where the dilemma is most acute. The Government believes that the RBI can stimulate growth by announcing bigger interest cuts and making more cash available through a more flexible cash reserve ratio and statutory liquidity ratio. But the RBI has vehemently stuck to its position that there is little room for such generous manoeuvre until the Government takes significant measures to contain fiscal deficit and inflation. It can be argued that inflation is now at its lowest since December 2009, but that is of little solace to either the people or industry which continues to reel from rising prices. RBI Governor D Subbarao said it all when he stated while announcing the latest cuts, that the “balance of risks stemming from the RBI's assessment of the growth-inflation dynamic yields little space for further monetary easing”. Despite the fact that there has been some surge in exports and a fall in commodity prices, the reality is that economic growth is still far from being robust. By the RBI's projection, the country's GDP will grow by 5.7 per cent — which is far from healthy.
Eventually, everything boils down to fiscal governance. The RBI cannot on its own kick-start growth through the reduction by 0.25 percentage points here and 0.50 percentage points there in interest rates. Nor can it glut the market with money through cuts in reserve and liquidity ratios. The apex bank can at best manage the monetary policy of the country, and the tools at its command to manage the flow of funds into the economy are limited. The Government, on the other hand, can do more by identifying wasteful social sector spending and cutting them down, as well as eliminating hazy policies that deter growth.