By Anish Mishra
September 28, 2015
The Reserve Bank of India (RBI) is gearing up to release its fourth bi-monthly monetary policy statement on Tuesday. Since his appointment as governor in 2013, Raghuram Rajan has reduced interest rates by 75 basis points in three policy statements, with cuts of 25 basis points each time. Last August’s policy statement saw the repo rate kept unchanged at 7.25 percent in the midst of the global economic slowdown, uncertainty over a U.S. Federal Reserve interest rate hik, and Indian monsoon expectations.Recently, Indian Prime Minister Narendra Modi and Finance Minister Arun Jaitley have been traveling the globe in search of foreign domestic investment (FDI), hoping to boost economic growth. The government has also made considerable efforts to boost public domestic investment. Indeed, India should be looking to increase domestic participation in its growth, creating room for more private domestic investment. If India does not invest in its own country, who will?
The biggest hindrance at present to boosting demand for domestic investment is the cost of capital, and thus Dalal Street has called on the RBI to slash interest rates and fuel the engines of growth. This should be done before the U.S. Federal Reserve decides to raise its own interest rates, which will cause a crowding out of investments from emerging markets into fixed income U.S. treasury bonds & U.S. dollar-denominated assets.
An understanding of India’s current economic situation strengthens the case for an interest rate cut. India uses two indices to measure inflation: the wholesale price index (WSI) and the consumer price index (CPI). The WSI has been in negative territory for nearly a year, currently standing at -4.94 percent, while August data has CPI inflation at just 3.66 percent. The uncertainty over a September U.S. interest rate hike is also now over, following the Fed’s decision to maintain the status quo. Meanwhile, the Indian annual monsoon has been positive. And although prices of vegetables in India have been rising, this is not due to inflationary pressure but rather the upward trend in the government fixed minimum support price (MSP).
Based on these macroeconomic conditions, it is hard to see any reason why Rajan should not slash interest rates on Tuesday. The index of vegetable prices should make an exit from the RBI policy framework, as monetary policy is not going to make vegetables cheaper. Rather, investment in smart farming technologies by the Ministry of Agriculture will reduce costs and make agriculture more profitable without increasing the MSP. Using the Fisher equation, real Indian interest rates currently stand at 3.59 percent, too high given India’s ambitions for economic growth. The RBI should look to bring down real interest rates to a more reasonable 2 percent.
My view is thus that on Tuesday, RBI Governor Raghuram Rajan should and will cut interest rates by up to 50 basis points, allowing rates to fall from 7.25 percent to 6.75 percent, thus completing his first century of interest rate cuts.
Anish Mishra is an Indian economist.
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