Reserve Bank of India Governor Sanjay Malhotra was bang on when he said at the FE Modern BFSI Summit on Friday that the 100-basis point (bps) repo rate cut in a span of less than six months has raised the bar for further easing of rates. Though Malhotra took care to add that any future action will depend on the outlook for both inflation and growth, the signal seems to be that the monetary policy meeting in August will be tilted towards a pause. Some believe the Monetary Policy Committee in its last meeting may have played its cards too soon, especially at a time when US President Donald Trump’s tariff tantrums have added a new and completely unpredictable dimension to the normal growth-inflation trade-off. But as the governor said, in a world of uncertainty, the economy can do with some certainty.
Monetary Policy
After all, monetary policy acts with a lag of many months and, therefore, the sooner action is taken, the sooner it will take effect. Indeed, the evidence on the ground is heartening. The 50-bps cut in the repo rate between February and April has been almost fully transmitted by June for fresh loans. That’s a fairly good progress and one hopes the transmission of the rate cut in early June will take place equally fast.
This is important because loan growth, for a variety of reasons, has been rather subdued and needs to pick up soon. In fact, one of the objectives of the chunky and up-fronted 50-bps cut in June, and the accompanying liquidity infusion measures, was to pull India out of a 6.5% growth trajectory and put the economy on a faster growth path. The idea is to push the economy to achieve its potential growth rate.
However, even 6.5%, which is the central bank’s expectation, is beginning to look increasingly difficult in an uncertain global environment. It’s not merely external headwinds that threaten to hurt the economy, domestic aggregate consumer demand at home remains weak with only premium goods and services selling well. In fact, with the rise in incomes having been weaker than consumption growth for households in recent years, a strong and sustainable rebound in consumption demand is clearly some time away.
Policy rates
That in itself is a good reason to lower policy rates by another 25 bps whether in August or in October. To be sure, retail inflation is estimated to go up to about 4.5% in FY27 from a little over 3% in the current year. But that’s significantly below the levels of 6-7% of recent years. Given how both consumer and investment demand are likely to remain subdued, the bigger priority for the central bank now should be growth which is showing signs of slipping.
There is ample evidence of this in the subdued demand for credit. Admittedly, softer lending rates cannot on their own drive up demand for credit; there must be appetite from borrowers. But lower rates can certainly play a role. For instance, large companies may be flush with funds and may not need to borrow but thousands of small and mid-sized firms do need credit at affordable rates. Since loan rates for these businesses are linked to an external benchmark, they benefit enormously, and immediately, from a cut in the policy rate. Lower interest rates on products like home loans would also ease the load on retail borrowers.