India Cuts Interest Rate to Boost Sluggish Economy

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RBI, India’s central bank, cut the repo rate by 0.25 per cent to 7.75 % on January 15.  Stocks and bonds rallied immediately after the announcement.  The Sensex, the Indian share market index, raised 729 points to close higher at 28,076.  It led to the rally in the bond market with prices of government bonds rising and yield, which is inversely related to price, falling.  The 10-year benchmark yield on government bonds fell 8 basis points to 7.69%.  One percent equals 100 basis points.

The repo rate cut would lower the market rate of interest.  The repo rate is the rate at which RBI lends to banks.  In turn, some banks have already lowered their lending rates, giving relief to individual borrowers and to corporate borrowers.  Home and auto loans will become cheaper.  Lower cost of funds for corporate borrowers will reduce input costs and reduce prices.  This would spur growth in Asia’s third largest economy.

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The present cut has come after a gap of 20 months; interest was last lowered from 7.50 per cent to 7.25 per cent in May 2013.  Subsequently, RBI hiked the repo rate to 8 percent to contain inflation which was pushing down the Indian economy.

Though India never went into recession; it passed through the slowdown phase for three years since 2011. The Indian economy faced problems of growth slowdown coupled with high inflation.  Retail inflation remained high around 9 percent for a long period.  The country also faced the challenges of the twin deficits – fiscal deficit and current account deficits.

In the World Economic Outlook, IMF observed that India’s potential growth has fallen because of “supply bottlenecks arising from problems in the regulatory framework for mining, energy, telecommunication and other sectors”.  RBI also pointed out that a continuous policy hold up brought the infrastructure sector to a standstill and project delays slowed down India’s growth.  India was shaken by decision-making paralysis and corrupt practices.

Only recently some positive news started flowing. First, announcement of the economic reform measures during the last six months created a positive environment for growth. Second, a sharp drop of oil price to six-year low helped India, a country which imports around 80% of its crude oil requirement. India’s crude import bill was $165 billion last fiscal year 2013-14. 50% drop in oil price is like a windfall of over $80 billion for India in a year.  It cuts the oil import bill, current account deficits and brings currency stability. It reduces the oil-subsidy burden of $ 15 billion; it brings down gap fiscal deficits.  The drop in oil is good news for oil consumers such as individuals and business.  Prices have started coming down.

The Indian economy seems to be emerging out from a slowdown.  India is likely to achieve an inflation level below 6% and fiscal deficits below 4% in 2015.  Low oil prices will keep current deficits below 2% and ensure currency stability around rupee 65 a dollar.  According to the World Bank’s report released this week, India is expected to grow at 6.4% in 2015 compared 5.6% last year.  It also forecast a higher growth rate of 7% in subsequent two years.

The author, Kanchan Kumar, is an MBA in Finance and MS in Statistics and has served as Executive Director and Advisor with several multinational companies, Financial Institutions and Universities.  He writes on Global Economy, Market and Personal Finance.

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