Banks may follow Rajan if he makes a policy rate cut

Retail inflation is in its four month low; and it lies at a level which is one and a half percent lower than the RBI’s target. The WPI inflation is continuing at the negative ranges.

Surely, there cannot be a better situation for Prof Raghuram Rajan to make a repo rate cut tomorrow.

Overall, the demand for rate cut is also strong. On its part, the government has given its vote for a rate cut. The business community also expressed its usual demand for facilitating rate cuts.

Definitely, the urgency in the demand for a rate cut is not just the prevailing low inflation rate. The latest GDP data available for the last quarter has shown a promising 7.5% rate. A rate cut contribution by the RBI is well anticipated by the government and the RBI.

The positive macro-data is enough for government to convince Prof Rajan the need for a timely interest rate cut by the RBI.

Already, the RBI has made two rate hikes this year-on January 15 and on March 4. But the present situation supported by growth figures is more conducive for the rate cut compared to those two situations.

Why there is the cry for the third cut in six months by the RBI? The answer is that the power of the cumulative effect of three rate cuts will make it compulsive for banks to make an interest rate cut.

If Prof Rajan makes the repo cut this time, it will produce a general interest rate fall in the economy. during the two previous cuts, many banks were not convinced about the duration of the rate cut impact . They have largely avoided cutting their individual interest rates to the previous two rate cuts by the RBI. Only the price leader, SBI and few new generation banks announced reduction of their interest rates.

Now, if the third cut in six months occurs, it will compel all the so far ‘unattended’ banks to follow the interest rate cut signal by the RBI.  This will bring the much demanded overall reduction in interest rate.