In past couple of years, there has been a strong demand for cut
in the interest rates. The cacophony rises multifold closer to the scheduled
meeting of the monetary policy committee (MPC) of RBI. Many experts have been
persistently citing lower rates as panacea for accelerated economic growth. In
past five years, since July 2015, RBI has halved its benchmark repo rate 8% to
4%. Despite this we have not seen any signs of acceleration in economic growth.
The credit growth has remained low and is expected to plunge to zero by end of
this year; as the supply of money (deposits) continue to outpace the demand
(credit)
A couple of months ago I had shared some random thoughts on the
utility of lower interest rates in the current economic environment. I
mentioned that "Interest rates are usually function of demand and supply
of the money in the monetary system. Demand for money is again impacted by the
level of economic activity and outlook in foreseeable future; whereas supply of
money is mostly a function of risk perception and relative returns"...and
concluded that interpreting these lower rates as supportive for growth would be
a huge mistake; just as it was with lower crude prices (see
here). In fact in the present circumstances, low interest rates are likely
to do more harm to the economy than help it. In next 12months, there is going
to be hardly nay growth in investment demand irrespective of the interest
rates. However, lower interest rates may damage the consumption demand as it
may lead to lower interest and rental income for consumers, negative real
return for savers, worsening income inequality.
Remember, lower interest rates because demand for money is less
is as bad a thing as in case of anything else." (see
full post here)
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