Fifth Bi-monthly Monetary Policy Statement, 2019-20 : RBI should reduce the repo rate by 0.5%

Let's look at some data points to support my suggestion that the MPC (in the statement to be released on December 5, 2019) should reduce the repo rate to 4.85% from the current 5.15%.

The economy has fallen off the cliff - for six consecutive quarters growth has slowed from 8.1% in Q4 of 2017-18 to 4.5% in Q2 OF 2019-20. Inflation has been benign and well below RBI’s target of 4%: except for last month's number of 4.69%, since July 2018 there has not been a single month when CPI inflation crossed 4%. Bank credit, the fuel that runs the economy has been at astandstill this financial year.

The international inflation environment has been benign. World growth has been tepid. The ECB, the Federal Reserve and Japan's central bank are in a easing mode. About $15 trillion of bonds, including some corporate bonds, in the developed world have negative yields.

Given the crisis of growth of India's economy, there is a strong case for the RBI to focus its energy on stimulating growth. To stimulate growth using the interest rate as a policy tool, the RBI needs to sharply reduce the real interest rate - surely to 0.5% or even to zero for a suitable period of time. 

The real interest rate prevalent in the economy is just too high. The table below gives the one-year treasury bill rate, CPI inflation, and the real rate, which is the difference between the two. As one can see, the real rate, as per this measure, has been well above 2%, which was at one time the target of the RBI.

The RBI needs to target a real rate of 0.5% or even zero. I feel that even if inflation perks up for the rest of the financial year to about 5% - a worst case scenario - there is still a case for a near zero real interest rate to stimulate growth.

A repo rate of 4.85% is quite consistent with this goal. 

Please see my earlier blogs on monetary policy, which will give a full background to my stance, in particular two notes titled A review of monetary policy: there is a serious need to correct flawed policy execution of June 5, 2109 and Monetary Policy: A look back over the last year of July 27, 2017.