Will interest rates come down?

In the coming week, the Reserve Bank Of India (RBI) is scheduled to meet in order to announce the monetary policy. This is the annual monetary policy for the year 2012-2013 (FY13). This announcement is something that everyone is eagerly awaiting. The reason - they expect the central bank to cut the interest rates.

Rising food prices and subsequently high inflation rates had led the RBI to adopt a tight monetary policy since 2010. Consequently it increased interest rates by nearly 13 times in the period between March 2010 and October 2011. The result is that the benchmark interest rates in the country stand at 8.5% currently.

The higher interest rates have certainly helped in cooling down inflation to some extent. The inflation reported for February 2012 was 6.95%. Though it is higher than the 6.55% seen in January 2012, it is still lower than the 9.54% seen during the same period a year ago. Even though the news on the inflation front has started to turn positive, the monetary tightening has had a side effect. And that is in the form of slowing economic growth.

With cost of funds being so high, manufacturing companies have either postponed or cancelled their investment plans. This in turn has hurt the economic growth which has come down to below 7% levels. And this is a cause of worry for the RBI. Therefore, it has two choices in front of it. The first is to do nothing. This means it would leave the interest rates unchanged. This in turn would mean that investment plans would continue being pulled back and economic growth would continue to come down. Alternatively, it could bring down the interest rates and infuse the much needed liquidity in the system.

Taking a cue from the RBI's actions since January 2012, it seems to be adopting the second approach. It has already cut down the cash reserve ratio (CRR) and has infused nearly Rs 800 bn in the economy. But this has not been enough. As a result, unless inflation concerns surface again, we feel that the RBI would loosen the noose in its upcoming meeting and cut the benchmark interest rates. But will it actually do so? We'll have to wait and watch.