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Policy rate cut by the RBI may not translate into lower bank lending rates
In an attempt to give impetus to investment and growth in the Indian economy, the RBI has cut policy interest rates by 25 basis points. This is a welcome move as investment shows no signs of picking up so far. The RBI appears to have responded to the steps taken by Finance Minister P. Chidambaram to cut the fiscal deficit as well as to restore optimism about the economy through a series of steps such as clearances for stalled investment projects. Keeping the fiscal deficit under control and reducing subsidies are factors that will determine the future direction of monetary policy and the scope for further easing.
The RBI has been cautious in its approach because inflation remains far above the target levels. Looking ahead, however, international commodity prices are expected to show a decline, both due to global developments in the oil sector and the decline in demand because of the slowdown of growth in China. Further, food prices remain high and the RBI is still unclear in its stance on how far monetary policy affects food prices. Supply shortages in food remain, especially in fruit, vegetables and fertilisers, and it is unlikely that they will go away soon. It is thus likely that the RBI expects that non-food prices will decline due to lower global and domestic demand factors, resulting in lower inflation.