RBI cannot ignore unemployment, must cut interest rates at monetary policy review

The RBI’s Monetary Policy Committee will soon roll out its bi-monthly monetary policy, which will determine the economic outlook of the country for the next two months.

Vijaya, Dena Bank, bank of baroda, BoB, Vijaya bank, Vijaya Bank merger, Reserve Bank of India, banking and Finance
The merger of Vijaya Bank and Dena Bank with Bank of Baroda, will be effective from April 1, 2019, said RBI. (Reuters)

The RBI’s Monetary Policy Committee will soon roll out its bi-monthly monetary policy, which will determine the economic outlook of the country for the next two months. In its last decision, they reduced the repo rate by 25 basis points owing to unfavorable growth, low inflation, and other broader economic factors. So what has changed since January?

India’s headline CPI inflation has been at 2.6% in February 2019 and is well below the target of 4%, which indicates that there exists room for a further rate cut. India’s farm sector has a significant dependency on monsoon rainfall, and IMD will soon release its annual rainfall forecast in the first week of April. A lot will depend on rainfall volume and the distribution of the precipitation. A good monsoon will mean good crop production, which is likely to depress the food prices and drive down inflation levels even further.

Although the RBI has given itself the mandate of targeting inflation, it cannot afford to ignore one of the most significant issues facing the country, that of rising unemployment. The employment rate remains high at six+ percentage and at an even higher rate amongst people with graduate and above education. This needs to be tackled urgently, and we believe that a rate cut will help companies to borrow cheaper, invest and consequently create jobs. A rate cut will also give a boost to the GDP growth rate, which has been disappointing in recent times. A GDP growth rate of 7.5% is achievable, and a repo rate cut at this stage should help to nudge the growth rate towards that figure.

Industrial production logged a lowly annual growth rate of 1.7% in January 2019. Credit growth, however, was robust at nearly 14%. Most of this growth can be attributed to durable consumer loans and personal loan growth, which shows that domestic demand, at least, remains strong. This bodes well for companies, as a rate cut to boost investment without adequate and sustained demand to back it up will be meaningless.

External Conditions

India being an importer of oil, crude prices majorly affect the outlook of our economy, and they have been at a relatively stable level for some time now. This means that fuel price driven inflation is unlikely to be a significant effect, at least in the short term, and gives the RBI the opportunity to loosen the policy rate and drive economic growth. Even the cycle of currency depreciation has seemingly come to an end and thereby frees up the Central bank from having to consider defending the Rupee by having higher interest rates in place.

Recently, in February, a fascinating phenomenon was noted in the US bond market. The yield curve on US government bonds turned inverted implying that yield was higher for short-term bonds over longer-term ones. This inversion of the yield curve is primarily believed to indicate the onset of recessionary conditions. The explanation goes that investors are seeking the relative safety of long-term US bonds driving down their yields. This in combination with the ongoing US-China trade war, the slowdown in Chinese markets, the uncertainty revolving around Brexit and muted demand in the Eurozone can be believed to signal a global downturn. The US central bank has also abruptly marked the end of the tightening cycle, and thus the MPC will be well advised to consider these conditions and reduce the repo rate to 6%. These policy actions have a lagging effect and will help to boost growth at least domestically that help to insulate the Indian economy from any possible slowdown in global markets.

The central banks of a host of other countries are also evaluating their policy rates at this time. The New Zealand rate has been steady at 1.7% for some time, and they have stated that the next movement will be a cut. Central banks in Australia, Malaysia, and South Korea are all widely expected to move their respective policy rates south.

Inflation at this time is tamed and expected to stay within the desired 2-6% range, while unemployment and growth are emerged as the conditions necessitates desirous of action. We, therefore, wish to see the Monetary Policy Committee further cut the repo rate by 25 basis points, staying true to the stance taken by the committee in its last meeting. This will ensure that we are not overtly conservative regarding the inflation situation, help the GDP growth number and optimistically generate employment through investment.

  • By Naliniprava Tripathy, Professor, IIM Shillong; Harsh Alipuria, PGP Final year, IIM Shillong; Parag Sharma, PGP Final Year, IIM Shillong. Views are authors’ own.

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