RBI Policy – Economy Impact: Much ado about rate cut. Prabodh Agrawal, India Infoline Ltd. (IIFL)

iiflThe banking sector, industry, and capital markets, among others, were expectantly waiting for the RBI to cut repo rate, which it duly delivered. This was the third repo rate cut this year, taking the cumulative cut to 75bps in 2013 and 125bps over the last one year. Rate cuts have the direct impact of lowering cost of capital in the economy, thereby spurring investment and consumption activities, while discouraging savings. Rate cuts also have an indirect positive impact on sentiments of the industry and consumers, even though actual spending may pick up with a lag.

But are we seeing these direct and indirect impacts, even though we are more than 12 months into the rate cut cycle? Against a 125bps cut in repo rate, banks reduced their lending and deposit rates by only 40-50bps in this period. Moreover, investor and consumer sentiment remain subdued, as reflected in very few new investment proposals and weakness in consumer spending from big to small ticket items. The latest round of repo rate cut too is unlikely to result in any substantive cut in banks’ deposit or lending rates.

So why has the monetary tool’s potency been undermined? Structural constraints like fiscal deficit, high inflation, unsustainability of the high current account deficit, and government’s policy paralysis have all contributed to erosion of investor and consumer confidence.  An interest rate cut alone will not be able to lift this. While directionally, one can argue, that some of the structural issues would turn better, investors need to see more evidence before committing themselves, given innumerable slippages in the past. This is the right thing to do. This also explains RBI’s cautious stance on future rate cuts.