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Reducing Interest Rate Will be Counter Productive

Low interest rates

The Monetory policy Committee(MPC) which is scheduled to meet today i.e 4th of August 2020 for 3 days headed by RBI Governor Shaktikanta Das is likely to debate on Repo Rate cut and set to announce its verdict on 6th of August. From February RBI already reduced repo rate by 115 Basis point impelling bank to reduce rate of interest on both Loan and Deposits.

Generally Purpose of reducing interest rate is not only to reduce overall cost of capital and make financial loan attractive but also to drive citizen to spends more rather saving. The interest on FD is significantly low as 5.10% on one year FD( SBI interest rates are parameter) against retail inflation of 6.09% in June. Which technically yield 1 % negative real rate of interest to Savers and should make savers to save less however as pandemic grows and people are more concerned about their lifetime savings bank have seen around 10% growth in deposit with credit take off almost reduced to half to 6 % from last year figure 12%. As per Care rating report Banking system in India is having surplus of 3.8 Lakh crore.

When MPC will meet they will surely discuss inflation rate as its above RBI target by 2%. one of the reason of increase in inflation despite low demand is Supply shock due to pandemic as factories are unable to work like before, also facing shortage of labour due to lockdown, so RBI is optimist about supply factor that it will improve as govt announced Unlock. However even the demad is low and to increase demand in market govt want people to spends more so to discourage saving RBI may try to reduce repo rate as its also in line of govt to reduce rate as even before Pandemic arrived RBI was cutting rate to make investment cheaper as FD rates were as high as 7.5% in June 2019 compared to 6.2 % in January 2020.

However its not just interest rate cut that allow business and start up to take loan and start investing in new ventures. There are lot of other factors which need to worked more not only to motivate people in this time of distress when uncertainty due to COVID has prevented borrowers from taking loan but also need to restore confidence of Banks to lend money which has failed despite giving guarantee and liquidity enhancement schemes by Central govt. For this banks should be given free hand without any kind of Intervention in future unlike Dilution of Insolvency and Bankruptcy Code gave wrong signal to banks and made bankers to believe that they can do very little when loan go bad due to corporate failure.

Also RBI need to come out with policy on Small loan as due to current Tax slab income upto 5 Lakh has been exempt resulting anyone can come with a ITR of Rs 4.9 Lakh and can apply for Credit card and small loan and it will be equivalent to Mudra loan which instead of boosting self employment fostering NPAs and bank is bound to turn away loan applications. it need to guide bank with monitoring repayment capacity as bank can do very little as legal cost in recovering small loans will be higher than loan amount itself.

Lowering interest rate will hardly change anything in terms of new loan and will make People especially senior citizens that contribute 35% in overall deposits to save more and spend little as they need some safe heaven with future certainity and wont invest in stock market despite stock market touching pre covid level. Mostly believe that its just a bubble as Sensex touched 38000 point from paltry 25000 point in March without any sign of revival of economy and current statement by SEBI “Falling FD should not drive investors to put money into market” wont prompt people to invest in Stock Market .

Its just matter of few hour to know whether RBI cut the repo rate or keep the status quo but in my opinion unless RBI comes with some unconventional policy to revive economy and banking sector rate cut will be counterproductive and wont lead to people spends more.

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