Can Low Interest Rate Revive the Indian Economy

Source: Reserve Bank of India

Low interest rates alone cannot revive an economy but there are more factors of influence.

India, being the largest democracy in the world by population, demands of its central bank to facilitate superior economic growth while also keep a keen watch on price stability. The Reserve Bank of India (RBI) is mandated to guide the market by flexing repo rates that governs the availability of money. The official repo rate indicates the benchmark rate of repurchase in the economy. Historically, India has seen a gradual decline in repo rates from about 14% in 2001 to 6.2% in 2016 including the latest reduction in October. When repo rates are reduced it expects credit market to grow and the economy to become financially inclusive. In contrast, when lending interest rates are lowered the economy expects credit line to grow and production to increase. Inflation needs to be controlled as much as the economy needs policy impetus along with easy availability of finance for steering the country’s economy forward. When these three combines, the inherent purpose of the RBI and the government is fulfilled to a significant extent.

The RBI recently reduced the repo rate by 25 bps to 6.25% on 4th October 2016, assuming the move will put some life back into the economy. A general traditional notion across the world that lower lending interest rates encourage buyers to stop saving and purchase more from the retail market may no longer be true. Multiple financial crisis, global, regional, and domestic have educated all citizens of the country to an extent that saving is seeing its importance back in Indian households. The RBI and the government assumes that lowering interest rates will encourage the retail market to thrive thereby increasing industrial production, entrepreneurial growth, and flow of money. However, looking at the world and especially in European countries where negative interest rates prevail, it is not difficult to assume the fate over low or even zero interest rates, since they have not been able to shift the economy to the growth trajectory. In addition, even when the RBI was lowering repo rates during 2014-15 the credit growth was declining, a complete reverse of what was expected. These events indicates that lowering interest rates is not the only key to unlock massive economic growth, but there are more factors of influence.

Low interest rates must be clubbed with high economic growth, which cannot exist without a political will to bring in bold reforms. Banks must be given a special bankruptcy code to comfort them from the fear of adding up more non-performing assets (NPA). The current NPA’s of banks must be cleared with government help to give confidence for further lending. Responsible lending must be a primary criteria of banks, encouraging new entrepreneurs and small enterprise showing promising future. Is the government capable of assuring the citizens of a crisis-less future when they encourage them to spend more? Is the government keen enough with a promising foresight to bring in new policies that drive growth and encourage domestic spending? Reforms, policy initiatives, prudent fiscal and monetary policy, domestic growth, cutting down dependency on international markets, and driving real industrial growth as the core necessities are prominent indicators of a healthy economy, without whom real long term growth cannot be registered and sustained.

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