The latest price data suggests that RBI’s real repo rate is already negative. Admittedly, inflation at about 6% could be a blip, or false, given the data fog of the corona crisis. Yet, it’s above RBI’s central target of 4%.
No doubt, our covid-battered economy needs all the help it can get, but there is good reason for the Reserve Bank of India (RBI) to resist a reflex rate cut this week. For one, banks are not short of money to lend. For another, after a series of slashes, the policy rate at which RBI lends them money is already down to 4%. Arguably, this ought to serve as a floor.
An interest rate is the price charged on money lent and what matters is the real rate, minus inflation. The latest price data suggests that RBI’s real repo rate is already negative. Admittedly, inflation at about 6% could be a blip, or false, given the data fog of the corona crisis. Yet, it’s above RBI’s central target of 4%. This figure is now known widely enough to serve as a benchmark of sorts. So a policy rate below its own inflation target would strike people as odd, even alarm depositors of a penalty being paid on money kept with banks, which usually pay only 1-2% more. Deposits earning less than inflation amounts to financial repression, which could send depositors fleeing to risky investments, if negative returns bother them, that is. Drop the repo rate below 4% and it may serve as an alert.
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