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With inflation ruling low, there is scope for reducing RBI's key policy rate by 25-75 basis points, said the Economic Survey released today.
The government came out with the second part or mid-year survey for the first time, highlighting new factors affecting the economy since the last such exercise earlier this year.
Broadly, the real neutral interest rates hover around 1.25-1.75 per cent, it said, adding that it "implies neutral nominal rates -- assuming a target inflation of 4 per cent -- of 5.25-5.75 per cent".
"Today's rate is 6 per cent or about 25-75 basis points above neutral rates," it added.
It also asserted that in the last 14 quarters, inflation has been overestimated by RBI by more than 100 basis points in six quarters (three in 2014 and three in the most recent period) with an average error of 180 basis points, and that too for a very short-term forecast, just three months ahead.
Noting that during 2016-17, gross bank credit outstanding grew at around 7 per cent on an average, the Survey said: "The sluggish growth can be attributed to several factors, including incomplete transmission of the monetary policy as banks had not passed on the entire benefit of monetary easing to borrowers."
It further pointed out that the twin balance sheet problem -- at the end of banks and corporates -- more attractive interest rates for borrowers in the bond market and from non-banking financial institutions are other reasons for slow bank credit growth.
The Reserve Bank of India cut the policy rate by 50 basis points during 2016-17.
However, it shifted its monetary policy stance from accommodative to neutral in February, and cut the repo rate by 25 basis points this month.
The Survey also said sluggish growth and increasing indebtedness in some sectors of the economy have impacted the asset quality of banks, which is a cause for concern.
The government amended the Reserve Bank of India Act, 1934, in May 2016 to provide for a revised monetary policy framework.
Under the amended Act, inflation target will be set by the government, in consultation with the Reserve Bank, once in every five years, which provides for a statutory basis to an empowered Monetary Policy Committee (MPC).
The government has fixed the inflation target of 4 per cent with tolerance level of +/- 2 per cent for the period beginning from August 5, 2016 to March 31, 2021.
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