To cut or not to cut the repo rate?

THERE IS ALWAYS a divided view on interest rates among economists. The question is what do we seek to achieve by lowering the rates? Lower rates theoretically help increase growth provided investment is held up due to the cost factor.

- (The author is chief economist, Bank of Baroda. Views are personal)

If investment is slow due to demand conditions, then lowering rates will not quite push up lending. Consumption is picking up but may not be to the extent to increase investment demand.

Interestingly, due to the concept of external benchmark lending rate (EBLR), all retail and MSME loans are fixed generally to the repo rate.

Therefore, all borrowers benefit automatically, thus leading to better profits as interest costs come down. As deposit rates also move down as a response to both repo and lending rates coming down, gains are, in effect, passed on to borrowers at the cost of savers.

The central bank researches showed there are limits to which lower interest rates can stimulate the growth process. Often an argument put forward going by the famous Taylor rule is that if growth is lower than potential and inflation is under control, lowering of rates help push up growth. This issue would have been addressed when the assertion was made.

The issue is that if the RBI lowers rates to, say 5.25%, will the cycle end at this point or will the same feeling echo before the next policy? This is because with substantial excess capacity in some sectors of the economy, actual growth will always be below potential and the justification for lowering rates can be endless.