Reserve Bank of India Governor Raghuram Rajan on Tuesday left repo-rate – the rate at which the central bank lends to banks – unchanged at 8 per cent. The status quo may have left some people disappointed but Morgan Stanley argues that it is the bitter medicine the struggling Indian economy needs right now.
India’s economy grew at sub-5 per cent for the second year in a row last fiscal, marking the worst slowdown in 25 years.
“I think the rates have to be held higher for some more time until the time inflation is seen to be systematically heading towards RBI’s comfort zone,” said Chetan Ahya, chief Asia economist, Morgan Stanley.
Mr. Ahya argues that higher interest rates will encourage people to save channelize their savings into financial products which can be used to revive India’s growth. “You need to have positive real interest rates, you need to encourage people to bring in financial savings into the financial system and then we can use that to push investment and growth.
“If we cut rates and leave real rates negative then it will be counter-productive and will not achieve the objective of taking growth higher,” he said.
Real interest rate is the rate which an investor expects after adjusted for inflation rate. In the current scenario, the real interest rate is next to nothing.
Retail inflation in April was at a three-month high of 8.59 per cent while SBI, the country’s largest lender, offers an interest rate of 9 per cent on 1-2 year fixed deposits.
Morgan Stanley expects inflation to come down to 7.5 per cent by March 2015 and it expects RBI to cut rate only early next year. “We think that rate cut will more likely be taken up around that time of March-April 2015 when the room for rate cuts will open up,” Mr Ahya said.
The RBI hopes to bring down retail inflation to 8 per cent by January 2015 and to 6 per cent in the following year.