Rate Cut Panacea

A policy rate cut by the RBI can spur consumer demand and industrial output, boost employment and scale up economic growth.

- DR T P MADHUSOODANAN

The Indian media has been abuzz with the RBI's Monetary Policy Committee (MPC) discussion on a proposed reduction in interest rates for the Indian economy. With inflation coming down and signals from other economic variables open to interpretation, there are a plenty of arguments as well as counter-arguments as to whether this is the right time for an interest rate cut.

In the backdrop of this discussion, let us examine the nation's inflation as well as other economic data and try to make some sense of them. It is also important to note that markets, both equity and forex, have been showing enthusiasm towards the Indian economy.

For all its intents and purposes however, a policy rate cut may be an appropriate action for completely different reasons. The Indian economy, arguably, is not necessarily in good shape. Policy initiatives to increase consumer demand are important in order to sustain the economy's growth and provide employment.

Shrinking output

It is obvious that inflation is slowing down right now, primarily due to a reduction in food prices. A crash in the prices of pulses and some vegetables has contributed significantly to this drop. But is that a sustainable trend?

Although the core inflation (inflation sans food and fuel) is holding steady, and it's still above the nation's inflation target, the low level of food inflation could be indicative of higher inflation in the future. One needs to examine whether the country's inflation is falling due to increased supply of food and food products alone, or whether there is a constraint from the demand side as well.