When the committee that sets monetary policy for India’s central bank meets early next month, their decision should be clear. There are plenty of good reasons for them to cut rates. Still, there’s one even better reason to hold off.
Since the committee last conferred two months ago, inflation has steadily declined. Food is cheaper now and overall consumer price inflation stands at less than 2%. That’s below the Reserve Bank of India’s (RBI) target zone, which gives the bank more than enough space to loosen policy.
And economic conditions would seem to cry out for lower rates. Growth has slowed for four consecutive quarters, with the last print coming in at a far-from-respectable (for India) 6.1%. While the International Monetary Fund (IMF) predicts India will grow at 7.2%, its most recent estimates have tended to be high.
It’s unclear what more the government — which in 2015 was promising to deliver double-digit growth but has now discovered how “difficult” that task is — can do to revive the economy. The real problem is that the private sector remains unusually unwilling to invest. Investment as a proportion of gross domestic product (GDP) needs to rise by several percentage points if India is to return to its previous levels of growth or to match China’s high-growth takeoff. The textbook advice is clear: To increase investment, lower the cost of capital.
But things never work quite that simply in India. For one, there’s no reason to suppose that a cut in the policy rate by the RBI would lead to entrepreneurs actually gaining access to cheaper capital. Both the current governor, Urjit Patel, and his predecessor, Raghuram Rajan, often complained that banks simply refused to pass on lower rates to their customers. Partly that’s because competition doesn’t quite work in the Indian banking sector, which is largely state-owned; partly it’s because most banks are struggling with bad loans. They’re feeling particularly cautious about new lending.
