In a step to increase the supply of money and boost the economy, the Reserve Bank of India cut interest rates by 0.50 percent on Friday.
The move had an instant effect on the stock market, with the NIFTY 50 and SENSEX seeing gains of around 1 percent.
2024-25 has seen India’s GDP grow by 6.5 percent. While impressive when compared to other large global economies, this was the slowest rate of growth in a year since the Covid pandemic. With lakhs of graduates and unskilled workers pouring into the job market every year, the country’s economy needs to keep ticking at a fast pace to accommodate all employment-seekers and a slowing economy is not the way to do that.
With inflation also coming down, the RBI saw this as a good time to slash the rate it charges banks to borrow from it, a cut that the banks will inevitably pass on to consumers. This rate cut comes on the back of two previous reductions in April and February.
This will make it cheaper to take out loans to buy houses, cars and other big ticket items and for companies to borrow to invest in their growth. It will also reduce the incentive to park money in the bank through fixed deposits or other saving mechanisms as the interest earned on such deposits will drop.
India’s GDP growth of late has largely been driven by central and state governments’ capital expenditure. Such spending is unsustainable in the long-run and the private sector needs to contribute to the nation’s growth, hence the incentive of a rate cut.
The RBI and other central banks usually raise or reduce interest rates 0.25 percent at a time. Anything more than that is usually considered bigger than normal. With the RBI slashing rates by half a percentage point, the central bank is sending a message that the need for a boost in economic growth outweighs its concern for inflation.
This is a balancing act for any central bank. Higher interest rates curb growth but also slow inflation down. Lower rates create a spike in GDP but also spur inflation along with it. That is the theory, anyway.
Along with the rate cut came an announcement by the RBI that it was reducing what is known as the Cash Reserve Ratio, namely, the amount of money that banks have to park with the RBI. The reduction from 4 percent to 3 percent, which will be phased in over several months, will increase the money supply in the economy.
Their effect on the stock market aside, rate cuts (or rises) usually take several months to have an effect on the actual economy.
Further rate cuts will depend on how India’s growth-inflation dynamic evolves. The globe is still in a precarious place, what with an unstable American government, Russo-Ukraine war and troubled Middle East, and factors like these and the weather (India being dependent on the monsoon for its agriculture) mean that there are no guarantees as to what the future holds.
