The Reserve Bank on Tuesday cut the key interest rate by 0.25 percent and introduced a host of measures to smoothen liquidity supply so that banks can lend to the productive sectors. Going ahead, the central bank hinted at a flexible stance. Given the weak private investment in the face of low capacity utilisation, a reduction in the policy rate by 0.25 percent will help strengthen growth, RBI Governor Raghuram Rajan said in the first bi-monthly monetary policy review for the 2016-17 fiscal. Accordingly, the repo rate, at which RBI lends to the financial system, has come down to 6.5 percent. The policy said the average overnight borrowings by banks have increased to Rs 1,935 billion in March from Rs 1,345 billion in January. Stating that the inflation objectives are closer to being realised and price-rise will hover around the 5 percent mark for the remainder of the fiscal, Rajan reaffirmed that the monetary policy will continue to remain accommodative to address the growth concerns. Home, auto, and other loans are set to become cheaper with the central bank reducing the short-term lending rate by 0.25 percent to over a 5-year low of 6.5 percent, taking the total cut to 1.5 percent since January last year. “Borrowing is cheaper...and will continue to do so", the Governor said, adding that the introduction of the marginal cost of funds-based lending rate (MCLR) system will improve monetary policy transmission.
The general assumption is that the RBI’s repo rate often sets the benchmark for those banks offering loans across the country both across medium and long term. Lower rates are meant to translate into more cash in the economy, and vice-versa. More cash in the economy with the availability of cheaper loans will subsequently spur consumer and industrial activity. However, the recent Economic Survey of India pointed out that banks do not necessarily work under such an assumption. "In 2015, there were no less than four rate cuts cumulating to 125 basis points, including a 50 basis point cut at the October meeting," the survey said. "But there has been much less ‘accommodation’ in bank lending rates, which have only fallen by around 50 basis points." In other words, even though the central bank has been lowering its rates, banks haven’t been following suit. The survey states that even though the RBI has actually lowered interest rates recently, the actual liquidity in the market has tightened for numerous other reasons. To address these concerns, the RBI has announced a number of key changes to its liquidity policies in its first monetary policy review of the new financial year to enhance cash flow. “For example, the RBI reduced the daily cash reserve banks have to maintain, lowered the penalty for banks borrowing above their quota, announced a Rs 15,000-crore infusion of funds into the system and said that it would no longer maintain a slight deficit of liquidity,” according to a report in news website Scroll. “In other words, the RBI has done its job – lowering its rates – and then done it twice over, ensuring that there is plenty of liquidity in the system."
Besides the announcement of a slew of liquidity-enhancing measures, the RBI also retained its GDP growth forecast at 7.6 percent, on the assumption of a normal monsoon and a boost to consumption through the implementation of the Seventh Pay panel recommendations. The central bank said it expects the implementation to hurt inflation by 1-1.5 percent over a two-year period, but added that the shock will not be as strong as that felt during the implementation of the sixth pay panel suggestions. There are more than three months to go before we head into the monsoon season. After two consecutive years of deficient rainfall, experts are sceptical of a fruitful monsoon season. If it follows the same pattern that the previous two monsoon seasons did, India could be on course for serious trouble. They contend that another year of deficient monsoon with no equivalent relief in oil prices will worsen the economic distress that has already afflicted rural India. Meanwhile, reports also indicate that India could in the near future become a net importer of essential commodities for the first time in many years. A growing population, consecutive drought years, falling commodity prices and a criminal lack of long-term investment in agriculture could seriously undermine India’s self-sufficiency when it comes to food items. Such shortfalls in farm output have opened the floodgates for foreign suppliers. In January, Reuters reported that India made its first purchase of corn in 16 years. The country has also stepped up its purchase of lentils and oil meals while traders fear that wheat and sugar stocks are depleting fast. According to a recent Associated Chambers of Commerce and Industry of India (ASSOCHAM) report, the damage done to the wheat output may result in a shortfall in production leading to a spike in the food inflation which may then contribute to the spiral of price rise. It was only recently that the spiralling price rise was relatively tamed after a prolonged gap. Unseasonal rains accompanied by hailstorms are creating havoc for Indian farmers continuously even as the country faces a shortfall in wheat production by around 13 million tonnes from the initial estimates of 93.8 million tonnes, as per the report. Noted observers have noted that if India wants to see a GDP growth rate of 7.5 percent, the agriculture sector must grow above 3 percent. The government claims to be on top of the current agrarian crisis. One can only wait and watch how the Centre, allied with the State governments, resolve this impending crisis.