The hypothesis of lower rates boosting the economy is put forth keeping only the borrowers point of view in mind. It completely ignores the savers' perspective.In his iconic investment book "The Templeton Way" legendary investor Late Sir John Templeton (of Templeton funds fame) advocated that he favoured investing in those economies that rewarded savers more than spenders. Rewarding savers is done by keeping interest rates higher than the inflation rate so that the saver still takes home some money after adjusting for higher costs of living.This inflation adjusted rate must remain positive so as to encourage savers to deposit money with the banks. Whenever inflation rises so must interest rates for depositors. Whenever inflation adjusted yields are negative, fixed income investors are forced to seek other higher yielding avenues to park their funds.This is possible in one of the two ways – either investors deploy money in riskier assets (like equities) to earn higher prospective yields or they deploy money in fixed income instruments in higher yielding economies. This flight of capital from lower interest bearing economies to higher yielding economies is called "cash carry trade." So far Indian bond yields have been significantly higher than western nations and have provided arbitrage opportunities to global cash carry investors to invest money in India. Should Indian interest rates fall, the cash carry advantage we enjoy will be negated to an extent. Couple that with our slowing GDP numbers and falling forex reserves and you have a heady mix for the RBI governor to handle.
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