What is the real neutral interest rate?

The Reserve Bank of India (RBI) has said that the neutral real interest rate in India is expected to be 1.5-2% for this stage of the economic recovery. This measure is the rate at which desired savings equals desired investments or the rate at which growth is close to potential and inflation is stable.

Why is this important?

As the Nomura economists point out, summarizing the observations of a recent RBI staff working paper, if projected inflation is above the inflation target, real real rates must be higher than the neutral real rate. to ensure that monetary policy is anti-inflationary. As the graph to the right from Nomura Global Economics shows, the real policy rate in India is close to the neutral real interest rate.

“The RBI study implies that optimal real interest rates should remain around 1.6-1.8% in 2016 (since inflation will be close to the 5% target), but above 1.6 -1.8% in 2017, since we estimate that inflation is likely. be above the 4% target (by Q1 2018), ”Nomura economists wrote in a recent memo.

This reinforces the idea that the RBI will forgo further interest rate cuts until the end of next year.

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