The RBI has delivered its fourth straight repo rate cut—the rate at which the central bank lends to all other banks. This has given rise to hopes that sectors that have been in a state of slump such as automobiles and real estate may see some revival. The repo rate has now come down to 5.4%, the lowest it has been since June 2010. The key challenge before the RBI and the finance ministry now is to get banks to pass on this rate cut to borrowers. If banks do make automobile and housing loans cheaper, market sentiments could improve with an uptick in demand, which in turn could in time lead to a virtuous cycle where investment would follow the rise in demand.
Encouraging consumer spending in an economic scenario that has been rather gloomy, seems to have been behind the RBI’s decision to go in for a 0.35% cut instead of its usual 0.25% cut. India’s GDP growth had slumped to 5.8% in the first quarter of the year, while domestic car sales had shrunk by nearly 25% in June. India’s core industries such as electricity and mining grew by just 0.2% in the same month. The continued weakness of headline consumer inflation CPI (3.2% in June) of course also played a role in the RBI’s decision.
The RBI itself admitted to the dismal economic picture by conceding “private consumption, the mainstay of aggregate demand, and investment activity remain sluggish”. However, despite stating this, the central bank still seems to believe that growth will pick up soon, and cut its own GDP growth projections by just 0.1% to 6.9%. While the SBI’s decision to cut rates by just 0.15% shows the continued reluctance of banks to pass on the rate cuts, empirical evidence suggests that rate cuts take time to be passed on to borrowers and borrowers take time in taking advantage of lower costs. India Inc., which is suffering from a huge unused capacity, will probably at this stage simply count its blessings in earning a reprieve by way of reduced outgo on interest payments rather than use the opportunity to take on new loans to expand or set up factories or enterprises.