Low interest rates aid decision-making

B. Venkatesh

THE market expects the Reserve Bank of India (RBI) to cut the bank rate sometime soon. A cut in the RBI's bank rate will be normally followed by a cut in the commercial bank's lending rate.

What is the implication of a lower interest rate on the economy? Let us consider sectors where interest rate plays an important role in decision-making. Housing finance, for instance. If interest rates are lowered, it is typical for people to demand more housing loans. Now, more housing loans will translate into demand for more residential properties. In other words, construction companies will have cement mixers running and their men working hard.

Besides providing more employment to the construction workers, this will have a positive effect on the other sectors as well. The demand for steel and cement, for instance, would increase. And that, in turn, would spark off demand for related goods. In short, the demand for goods and services in the economy could increase as a result of a cut in interest rates.

Now, all this is good news for the people. Why? To meet the higher demand from consumers, producers will manufacture more goods. And that could sometimes mean hiring more workers.

Of course, the above picture is the most optimistic view of the possible economic impact due to a rate cut. Reality could be a lot different. For instance, some consumers may not demand more housing loans if there were to, say, expect the rates to go down still further sometime in the future. In other words, these consumers could postpone their current consumption for a later date. The economic impact of the rate cut will then be smaller.

In any case, the impact on the economy will not be felt immediately. It takes time for the supply to adjust to the increased demand. For instance, it takes a long while before a housing loan application is translated into demand for a residential house. But this apart, a rate cut normally augurs well for an economy like ours that is not growing at a fast pace.