ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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A Heady Brew

Widening interest rate differentials compound the problems of monetary management.

The Reserve Bank of India’s (RBI) third quarter review of monetary policy has left the bank rate, the repo (and reverse repo) rate and the cash reserve ratio unchanged, this even in the face of the US Federal Reserve cutting its key interest rate, the federal funds rate, by 75 basis points a week earlier. This reduction, the biggest in one go in two decades, came on the heels of the plummeting of global financial markets on apprehensions that the US economy was heading into a recession. This has been quickly followed by a further cut on January 30 of 50 basis points, taking the funds rate to 3 per cent. The Federal Reserve has signalled that further cuts are possible.

The cuts in the US and the status quo in India widen the interest rate differential by 125 basis points in just over a week’s time, raising the possibility of a further inflow of portfolio capital. The RBI’s decision to hold rates was influenced by the need to maintain a watch on inflation, which rules low only because the impact of high global oil prices is not yet fully reflected in retail prices of petroleum product prices. Nevertheless the RBI has made it clear that it will act, if necessary, on interest rates and with the further lowering of interest rates in the US on January 30 one can expect an appropriate signal sooner or later from the RBI.

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