RBI at end of rate­cut cycle

RBI at end of rate­cut cycle

• The Reserve Bank is at the end of its rate­cut cycle as inflation is unlikely to decline materially from the current level, and the onus of economic recovery has now shifted to the government
• Where high inflation was cited as the prime reason for the unanimous decision to hold rates
• To push economic growth, but surprised many by holding rates at the August review as inflation overshot its target.
• Fiscal policy should play a decisive role if we have to nurture any hopes of a fastpaced recovery
• We now believe that we are at the end of the rate-­cut cycle and expectations of large rate cuts must be anchored as inflation is unlikely to decline materially from the current level
• Hinting at best there can be a 0.25% more of rate cuts in the offing
• The economists said they feel inflation — which came at 6.9% for July — could be sticky because their estimates show the large procurement by the government may have resulted in 0.35-­0.40% upward impact.

Let us understand a few points of the news but before that one concept:

• Nominal Interest rate = Inflation + Real Interest Rate
• This formula is for anyone and not specific to depositors only. It is for RBI, banks, people, borrowers anyone.
• Nominal means something which u get/pay in CURRENCY terms. For example, you deposited Rs. 100 in a bank at an interest rate of 8%. So, every year you will get RUPEEs 8 as interest from the bank in the form of Rupee/Currency. So, this Rs 8 ( or 8%) is called nominal interest rate but if inflation is 7% then basically u benefitted just 1% i.e. your actual return is just one percent which is called real interest rate (or real return).
• For example, I borrowed money from the bank at 9% interest. Then this 9% I will be paying every year to the bank in currency terms, so this 9% is the nominal interest rate. But if inflation is also 9% then it means I am not paying any real interest to the bank. The rupee is losing value by 9% every year (inflation 9%) and I am paying 9% interest every year, so I am not paying anything extra (real) to the bank. And I will say that my real cost of borrowing is 0%.

Now the NEWS:

• Monthly inflation is hovering around 6% (just for July it was 6.9%). Since RBI reduced the repo rate (to push for economic growth), reverse repo rate got reduced and deposit and lending rate also got reduced. Now the deposit rates in banks have come down below 6% (most of the banks are giving between 5% to 5.5%). This is creating a problem. If u deposit money in the bank at 5.5% and inflation is 6%.............then basically you are losing money (real interest rate becomes negative of -0.5%). This is leading to people moving their deposits from banks to SHARE MARKETs which is rising like anything (not at all in sync with the economic reality, there is another news in HINDU, the image shared below). The fear in the minds of the people, because COVID is not leading to increased purchase of goods and services and demand, is not picking up even from those people who have money. When the demand is not picking up..............businessmen are not willing to invest even if the REAL cost of borrowing for them is almost negligible (borrowing rate 7%  and inflation 6.9%, SO real interest rate = 7% - 6.9% = 0.1%). 
• All this is leading to an unrealistic boom in the stock market and which may crash in the future because it is not supported by actual real economic activity on the ground. The Indian stock market is also booming because more foreign money is coming in (sufficient foreign liquidity) and hence our FOREX is also increasing.
• SO, RBI has said that NOW it has reached at the end of the repo rate cut (cycle) and it cannot further reduce it beyond 4%. (REPO RATE CUT SHOULD BE IN SYNC WITH INFLATION. RBI SHOULD CUT THE REPO RATE ONLY WHEN THE INFLATION IS COMING DOWN OTHERWISE IT WILL LEAD TO A LOT OF PROBLEMS EXPLAINED ABOVE)
• So, now the ball is in Govt's court and it should focus on its FISCAL POLICY (fiscal means related to govt expenditure and tax policy). When govt will spend more may be on the construction of infrastructure then money will directly reach the public and economic growth may be revived.

There are two terms used in the last column, its meanings in the context of today's news are:

• ANCHORED:   Stopped
• STICKY:           Not going to change

Source: The Hindu