On Wednesday, the Monetary Policy Committee unanimously voted to cut interest rates by 35 basis points to 5.40 percent. In its monetary policy review, RBI also acknowledged the economic slowdown at global and domestic level and subsequently cut GDP (gross domestic product) estimate for the financial year 2019-20 to 6.9 percent from the earlier 7 percent.
Today's repo rate is the fourth consecutive one. This kind of repetitive interest rate cuts were last seen after the 2008 recession where major central banks were desperately looking to revive economic growth.
The MPC also decided to maintain the accommodative stance of monetary policy in line with its objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent, while supporting growth.
The RBI said that its main considerations to take the decision included the current state of global and domestic economy. "Global economic activity has slowed down since the meeting of the MPC in June 2019, amidst elevated trade tensions and geo-political uncertainty," it said.
In the Indian scene, late arrival of monsoon this year has reportedly lowered the total area sown under kharif crops by 6.6 percent as on 2 August than a year ago, RBI said. IIP (index of industrial production), that measures industry growth in the country also moderated in the month of May with deceleration in manufacturing and mining including a fall in production of capital goods and consumer durables. The growth in the index of eight core industries decelerated in June.
However, "Reserve Bank's business assessment index (BAI) for Q1:2019-20 improved marginally, supported by a modest recovery in profit margins of the surveyed firms even as production and order books slowed." Meanwhile, service sector activity gave a mixed picture.
Merchandise exports contracted in June 2019, weighed down by the subdued performance of gems and jewellery, petroleum products, rice, engineering goods and cotton.
The cut in GDP forecast comes at a time when the government has set a target of making India a $5 trillion economy by 2025.
In a recent research report titled "Economy Watch" by EY, the financial services firm said that at the projected rate of 7 percent growth for the current financial year (FY), India's GDP will increase from $2.7 trillion (in the previous year) to $3 trillion.
It further said that to achieve Modi government's target of becoming a $5 trillion economy, the GDP will have to grow at 9 percent in each subsequent FY, that is $3.3 trillion in FY21, $3.6 trillion in FY22, $4.1 trillion in FY23, $4.5 trillion in FY24 and $5 trillion in FY25.
How does repo rate cut help the economy grow?
Repo rate is the rate at which the RBI lends money to its clients (like banks and other lending businesses). In the monetary policy review, the central bank decides to lower or increase or not make changes to the repo rate based on economic conditions. In the present scenario where the country's growth has been seen slowing down, cutting down interest rates will reduce burden on banks who will cut their interest rates thus encouraging more people and businesses to take loans.
When money circulated increases, economic activities will increase, aiding growth. On the other hand, when rates are increased, it will encourage people to save more and deposit money in banks.