Why RBI held onto the status quo

The Reserve Bank of India decided to hold its rates in the Monetary Policy Committee meeting on the December 5 2019.

The reaction to this decision was well received by the analysts of the economy. But still, there was a group that expected the RBI to cut the rates.

Why did people expect the RBI to cut the rates?

We expected the RBI to cut rates because the state of the economy is far from showing any signs of recovery. The GDP growth is down, and there is no improvement in private investment either. By reducing the interest rates further the RBI and the government might’ve hoped to stimulate investment.

Why was no one shocked on the status quo of the interest rates?

We weren’t really shocked because even though it seemed like common sense to reduce the interest rates to stimulate investment, it somehow didn’t seem to work.

The RBI has reduced the repo rate 5 times already and there has been no significant effect on the economy or private investment.

Why hasn’t the rate cut made a difference?

It’s simply because of 2 main reasons,

1. Banks aren’t ready to pass on the benefit

With reduced interest rates, once would assume the commercial banks would reduced their lending rates and pass on some benefit to the consumers, but this didn’t happen. There are many reasons for this, the banks are already over streched with advances, the banks have mounting bad debts and fit because there aren’t enough quality borrowers inthe market.

2. Inflation is high

Due to an increase in fuel prices and food inflation, the WPI has increased to 4.9% which is well above the RBI’s target of 4%. Making further reductions would mean more money in the economy and hence trigger more price rise.

There is also a 3rd reason, since the economy isn’t that great, there is no need to invest right now in India. A rich investor who has easy and cheap access to funds in India would be tempted to borrow in India at a lower price and invest abroad. Already our foreign remittances are increasing, we don’t want to encourage further remittances do we?

Hence it makes perfect sense for the RBI to hold its rates.

But this leaves us with a site thumb. Who then will stimulate the economy? In 2011-12 when Pranab Da ended up over stimulating the economy, his only fault was just relying on the monetary policy and loosening it without care or concern.

Today we can’t rely on the monetary policy alone to get the economy back on track, we need the finance ministry to manage the fiscal policy and help revive the economy.

But now another question sticks out, does the government have any money left to do fiscal policy changes?

Where’s all the money gone? Why has GST failed? I guess that’s another blog.

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