Mains Paper 3: Economy | Mobilization of resources
Op-ed discusses about the impact of repo rate change on common man and it also gives, reasons why RBI should cut repo rate more.
Once you are done reading this op-ed, you will be able to attempt the below.
Discuss the impact of change in repo rate on common man? why it is said that RBI should be more aggressive in cutting the repo rate?
From UPSC perspective, the following things are important:
Prelims level: Repo rate, reverse repo
Mains level: Monetary policies of RBI and its impacts on economy
- The Reserve Bank of India recently decided to lower the repo rate by 25 basis
- Ordinary citizens treat this as an abstruse topic, of no concern to them. In reality, the lives of ordinary citizens are greatly affected by it
Why this is important?
- The repo rate is the interest rate at which banks can borrow money from RBI for short durations
- If this is lowered, banks can lend to their borrowers at lower rates.
- This is the reason why changing this rate usually influences interest rates across the economy
- Raising the repo rate lowers inflation but also restrains growth, while lowering it pushes up the growth rate but fuels inflation.
Why RBI should be more aggressive in cutting the repo rate?
- There is no indication of rapid, generalised inflation in India.
- In an emerging economy, it is good to have an inflation rate of around 3 to 4 per cent. This makes the labour market more flexible and facilitates job creation.
- As a result of the liquidity crunch associated with demonetisation, GDP growth in India is now down to 6.1 per cent per annum. Some additional liquidity could partially offset this.
- Drop in the amount of investment taking place in the country. India’s investment-to-GDP ratio had risen since 2003 and was steady at above 35 per cent. This has now dropped to 28 per cent.
- The world is today caught in a low-interest rate regime. The European Central Bank cut its overnight deposit facility rate to below zero; and this prompted central banks in other countries — Sweden, Denmark, Switzerland, Japan, Hungary — to cut policy rates and enter negative territory.
- Such extreme low rates are, far from boosting consumption, making people save more since they are worried about not having enough money at the time of their retirement.
- Even the US Fed is more cautious about raising rates, because it would increase demand for dollars and cause the dollar to appreciate and hurt American exports.
Increase interest rate?
- If one country raises interest rates, money will flow into the country from the other economies in order to earn the higher return.
- As more players try to buy this country’s currency to invest in it, the currency will appreciate, causing exports to suffer.
- By holding on to high interest rates, it is attracting capital flows into the country, as evidenced by the large foreign exchange reserve held by RBI.
- This is causing the rupee to be stronger than it should be and this is, in turn, stunting exports, and growth