Why mpc should lower policy rates

Why mpc should lower policy rates

By conventional yardsticks, there is no call for the Monetary Policy Committee (MPC) to reduce the policy rate when it announces its decision on August 6. However, the MPC should lower the repo rate, at least by a token amount.

This is to signal our monetary authority’s support for reviving growth, empathy with the suffering public and reduce, even if by a tad, the accumulating interest burden on companies that are raising debt to stay alive, perchance, to do actual business, if and when orders materialise.

Admittedly, the rate of inflation, as measured by RBI’s target price variable, the consumer price index (CPI), is above the comfort zone of 4%. In fact, real interest rates are negative at the moment. The call money rate has average not only below the repo rate but also trended down over June-July.

The credit-deposit ratio is well below 80%. Banks are flush with money and can lend, if they choose to. Lowering rates further might actually inhibit them from lending. All these factors militate against further lowering the repo rate. However, all these factors also reflect the past, rather than the future. Inflation has been a result of supply constraints, not excess demand — the economy is deflating.

As the lockdown-induced restrictions are removed, supplies will ease and inflation will disappear, sooner than people imagine. Real interest rates will turn positive again. Small and medium companies are being given government-guaranteed debt.

That does not mean that companies are either liberated from having to pay interest or at liberty to default on loans and spoil their credit history. They need their interest burden to be as low as possible.

Ideally, the government should activate its promise of a fund of funds for small industry and give companies funds as equity, rather than as credit. Of course, the government would have to borrow, to provide those funds. The biggest beneficiary of lower rates would be the government itself. The MPC should look ahead, rather than to the past, and announce an accommodative stance of monetary policy, complete with lower rates.