Honestly, I am surprised, agitated, furious and even puzzled at recent focus around the 110-basis point cut in repo rates since January 2019. A recent article by Dr Bhalla for the Indian Express (you can read it by clicking here) summarized the fallacy of articles that have supported the decision of the MPC to cut policy rates by 35 basis points.
All of us should be worried and concerned regarding the way monetary policy is being formulated in the country, more so the government which is trying to revive growth through a combination of policy instruments. Without support from our monetary bosses, the job of North Block is twice as hard. In their ways, it’s trying to compensate for the same but at some point, our monetary masters will have to correct for their mistakes.
For now, let’s remind ourselves with the first lesson of economics- always look at real variables rather than nominal ones. This is extremely important for the MPC as it keeps looking at the nominal repo rates while we continue to have one of the highest real interest rates in the world.
A recent article by a commentator in Hindustan Times caught my attention as it mentioned that the MPC had little ability to stimulate growth. The author argued that a 110-basis point cut has failed to stimulate economic growth so far and therefore the monetary policy is likely to have little impact. Now here’s where I have a problem with this assessment- it’s comparing nominal interest cuts with real economic growth and trying to draw an inference. One of the reasons why the 110-bps cut have not had an impact on growth rates is because the cuts have been far too little. Let’s look at the real repo rates for instance, and the moment we look at them we find that despite the 110 bps cuts since January 2019, real repo rates have averaged higher than between May 2018 and December 2018. (refer to an earlier article on this issue by clicking here.)
Yes, real repo rates have as a matter of fact increased because inflation since January has been lower than last year. India’s real interest rates are at 2.2 per cent down from 3.43 per cent in April 2019. The average real repo rate was at 2.8 per cent during the first half of this financial year. Would someone explain how will the monetary policy have an impact on growth when instead of lowering real interest rates we have in fact increased them?
Another assertion made in the article is to do with aggregate demand being a week and therefore lowering interest rates can only have a limited role in the revival. One must remember that in the United States during the early 2000s when interest rates were lowered it led to a massive surge in consumption expenditure. The economy expanded for several years until the North Atlantic Financial Crisis occurred but there are different reasons behind the 2008 crisis. There’s evidence that cutting rates (real rates) can have a significant impact in improving consumption expenditure.
In the case of India, one must remember that while consumption has grown by approximately 50 per cent between 2013 and 2017, household debt (or personal loans) have increased by almost 90 per cent. Further, EMIs formulate a sizable proportion of expenditure for the households and therefore once real interest rates reduce, and EMIs are brought down we will have more money with households available to spend. Doing so would require EMIs and lending rates to be linked to real policy rates and therefore some banking reforms would be required to improve monetary transmission.
Irrespective of the reform, the fact remains that despite a 110-basis point cut our real interest rates have shot up and therefore we should start asking the MPC some serious questions. As far as revival of growth is concerned, one shouldn’t write off the important role of monetary policy. Getting our monetary policy is a necessary condition for sustaining a high growth rate and therefore the MPC should take a good look at the real policy rates across the world.