Budget 2017 and interest rates-the connection explained
The Union Budget for 2017 focussed on a lot of things: agriculture, youth, healthcare, infrastructure, housing and so on. However, if there is one common factor that connects most of these sectors, it is interest rates. Whether it is agricultural loans or home loans or educational loans, everyone wants a reduction in interest rates.
Let’s study the connection between the budget and interest rates:
- Demonetization and loan rates
Demonetization has created a huge surplus in banks all over the country. Due to this reason, the Finance Minister believes that there is an increased capacity of banks to lend at reduced rates. So borrowers who wish to take housing loans, personal loans or any other kind of loan from banks can expect a reduction in rates in the near future.
- Fiscal prudence
The government’s commitment towards fiscal consolidation was clearly evident when the Finance Minister pegged the fiscal deficit target at 3.2% of the GDP for the year 2017-18. Keeping in mind the need for public investment, the government seems committed to achieve the 3% target in the following year. Lower borrowings by the government will push interest rates to go down. This perfectly sets the stage for an increase in consumption all sections of the market.
- Pressure on RBI
The government’s goals on fiscal prudence will now put direct pressure on the Reserve Bank of India (RBI) to slash interest rates. With the monetary policy review meeting less than a week away, there is a lot of expectation for a rate cut by the RBI. However, an increase in bank deposits and easy liquidity should help in lowering of interest rates without even a rate cut.
- Economic conditions
Given the current nature of the Indian economy post demonetization, many believe that the RBI will defer a decision on cuts till April. On the other hand, a cut in lending rates by as much as 50-75 bps is expected to occur by September in order to offset the impact of demonetization, according to a research note by Bank of America Merrill Lynch.
Based on the Finance Minister’s speech, there are huge expectations for a reduction in rates. However, it all depends on the outcome of the monetary policy review on 7 February. Until then, let’s wait and watch.