The rate cut by the RBI is expected to address the two structural issues haunting the Indian Economy. What are those issues?

The Reserve Bank of India (RBI) has cut its lending rate to the banks by 135 basis points (or 1.35 percentage points) in the span of nine months since February.

Why RBI is on rate cut spree?

India’s economic growth momentum is rapidly decelerating. Projections of GDP growth rate have come down from 7.2%-7.5% in February to 5.8%-6.0%. The lower interest rate regime is expected to help in resolving two key problems haunting the economy.

Reduced Consumption

People are not consuming at high enough rates. Hence the RBI is going by the argument that if banks reduce their lending rates, they would also be required to reduce their deposit rates (the interest rate banks pay when we park our money with them in a savings bank deposits or a fixed deposit). This, in turn, will incentivise people to save less and spend more.

Reduced Investment

The other problem haunting the Indian economy at present is that businesses are not investing in existing or new facilities. Part of this behaviour is attributed to the fact that that they have unsold inventories because people are not buying. As much as a result of which they are under the mindset that what is the point of borrowing money and investing.

The other reason for such behavior is also due to the fact that the interest rate charged on loans is quite high. Hence an argument is forwarded that if banks reduce the interest rates on loans, more businesses are likely to be enthused to borrow new loans for investment.

Hence the RBI is on a rate cut spree to address these two structural issues.

Topics: GS-III: Economic Growth Development