Expert Zone
Straight from the Specialists
Should the RBI delay a rate cut?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
With the return of inflation, there are doubts whether the Reserve Bank of India (RBI) will go in for the next cut in repo rate any time soon. In April, inflation was up at 7.2 percent, 2 percent more than in March.
What is more disturbing — the food component of inflation was in double digits. With the extreme sensitivity of the RBI to inflation, it is difficult to expect it to take kindly to the fall in industrial production and cut the repo rate.
Food inflation, however, is not the parameter for the RBI to go by because it is outside the impact area of RBI policy. No one buys food by borrowing from the bank and, whatever the interest rate, the expenditure on food will not be reduced and food inflation will not ease.
It is more relevant for the RBI to look at the core inflation or principally, inflation in the industrial sector. No doubt, prices of industrial products have also been rising but at a much slower rate. In April, prices of industrial products were up 1 percent over prices in March. Inflation in the industrial sector was 5.1 percent over the year, well within the RBI’s tolerance limits.
Industry is the major sector that responds to RBI policy. An increase in the interest rate will most certainly crunch investment and a cut, stimulate it. In March, for instance, investment was down 21 percent because 142 projects involving an investment of 1,553 billion rupees were shelved, being rendered unviable due to the high rate of interest and absence of market for equity.
But the RBI’s single target is inflation. Even on April 17, the cut in repo rate was done quite reluctantly though it was a good beginning. It is critical that it has to be carried forward before it can regenerate investment and revive growth. The RBI had done that in 2008 when the economy had slowed down. The repo rate was 9 percent in 2008 and the RBI cut the rate by 1 percent in October, in spite of inflation raging at 12 percent. That cut was followed by another in November and once again in December. In just three months, the repo was down 2.5 percent from 9 to 6.5 percent, with inflation dropping to 5 percent.
Investors shouldn’t read too much into repo rate cut
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The last time the Reserve Bank of India (RBI) surprised the markets was when it announced a 75 bps cut in cash reserve ration (CRR) days before its mid-quarter review of monetary policy on March 15. It did so again in its annual monetary policy meeting on April 17, with a 50 bps repo rate cut when the markets were either expecting no rate cut or a 25 bps rate cut at best.
Why did the RBI cut the repo rate by 50 bps, amid growth showing signs of a recovery and the general belief that the worst in industrial growth was already behind us; when food inflation had started rising and with all the suppressed inflation in retail fuel, coal, power and fertiliser prices?
Did it give in to moral persuasion from the government and the industry? Or was it because cutting rates later in the year would have been difficult, if not impossible? As if to mock the rate cut, consumer price inflation for March came in at 9.5 pct the very next day.
As per media reports on April 19, the Commission for Agricultural Costs and Prices (CACP) recommended a hike of 15-40 pct in the minimum support price (MSP) of various kharif crops during FY13. Though these are just recommendations, historically, the actual hike in MSP has almost matched the recommendations. This is again likely to add to food inflation. With the current account deficit likely at 4 pct of GDP in FY12 putting further pressure on domestic currency and the consequent need for overseas inflows to finance the same, a rate cut was the last thing that should have been done.
Also, the uncertainty relating to monsoons, spike in food inflation after the transitional decline in Dec and Jan 2012 and the impending retail fuel price hikes, all create doubts over the continuance of the trend in the foreseeable future.
The RBI Governor said “the reduction in the repo rate is based on an assessment of growth having slowed below its post-crisis trend rate which, in turn, is contributing to a moderation in core inflation. However, it must be emphasised that the deviation of growth from its trend is modest. At the same time, upside risks to inflation persist. These considerations inherently limit the space for further reduction in policy rates.”
RBI rate cut — too little, too late?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The RBI Governor cut the repo rate on April 17 quite reluctantly, even hinting there wouldn’t be another cut soon. Perhaps, he was under pressure from elsewhere, compelling him to look beyond inflation which had been his sole criterion in raising the repo rate.
The surprise was that the RBI cut the rate by 50 bps in one go. What the market expected was 25 bps because that is the speed at which the RBI has been moving since March 2010, except on one occasion when the rate was raised by 50 bps. Will the drop in repo from 8.5 to 8 percent make all the difference?
A 50 bps reduction does not mean that banks will slash their interest on credit correspondingly. After all, the repo is the rate at which banks borrow from the RBI. These borrowings are a small part of their total operations. What matters more is the interest on deposits which banks may take some time to reduce. Therefore, at best, the reduction in interest on credit can be 25 bps. That is unlikely to rev up the debt market.
Take home loans which are generally for long periods and therefore the interest rate becomes an important consideration. On a loan of 2 million rupees payable in equal instalments over 20 years, the saving in interest with a 25 bps reduction would be 170 rupees a month. That is too little for any home buyer to be excited about. That is also true of the corporate sector though the stock market reacted favourably.
The cut in the repo rate is nevertheless a good beginning. But it has to be carried forward before it can regenerate investment and the economy. The RBI had done it in 2008 when the economy had slowed down following the world financial crisis. The repo rate was 9 percent in 2008 when Lehman Bros collapsed and the RBI cut it by 100 bps in October. That was followed by another 50 bps cut in November and 100 bps in December. In just three months, the repo was down 250 bps from 9 to 6.5 percent. Not that there was no inflation. Going by WPI, inflation was 12 percent in August 2008 which declined thereafter in spite of the sharp cut in interest rates. But consumer prices, mainly due to food inflation, were high. Food inflation is a problem by itself unrelated to the rate of interest.
The choice before the RBI is really to have a high interest rate with low growth and high inflation or to have low rate of interest with high growth and high inflation. The latter would be a better choice. That would require that, as in 2008, the repo rate has to be cut not by 25 or even 50 bps but by 100 bps to get it down to 6.5 percent in the next three months and take investment back to 30 percent of GDP.
Will the RBI change its mind?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The RBI seems to be almost obsessed with the high rate of interest. At the January review of credit policy it remained silent and on March 9 made an unscheduled announcement about the cut in CRR to make up for the shortfall in liquidity. Though this infused 480 billion rupees into the banking system, it did not ease interest rates in spite of persuasion by the Finance Ministry.
The RBI hesitates to shave off the repo rate because inflation is still around 7 percent though down from its peak of 11 percent two years back. But the high repo rate is causing development to slow down. That is visible from many unmistakable signals. Last February the growth in industrial production dropped to 4.1 percent; in July-September 2011 national investment y-o-y was down from 30.3 percent of GDP to 28 percent and the GDP growth itself from 8.4 percent to 6.9 percent. Broadly, the 225 basis points rise in interest rates caused national investment to shrink by 621 billion rupees, leading to a GDP loss of 1.03 trillion rupees.
The slowdown in the economy is not limited to investment and income alone though these are critical. It has a secondary effect on other parameters, more importantly employment generation. Each percent drop in GDP growth means denying possible employment to 1.5 million workers.
A cut in repo rate has become vital to reverse the drift in development. Two questions are relevant. First, when should the repo rate be reduced? And, second, what should be the extent of reduction in repo rate?
Going by the experience of 2008-09 when the economy was in similar conditions, a quick reversal of GDP growth became possible because the repo rate was reduced from 9 percent to 4.75 percent in just a few months.
The RBI has been careful to ensure that the interest rate for the government did not increase commensurately. Although the repo rate was up from 4.75 percent at the beginning of inflation to 8.5 percent now, the yield on 10-year government bonds moved in the range 8 – 8.5 percent. But the full increase in rates was passed on to private businesses and individuals.
Really ! The author does not believe that the RBI has a “MIND”. The RBI is also brainless or braindead. Too many ‘fake’ economists are in charge of policy making right frpm the PM and his advisors to the RBI guv. Give me good ol BEN any day.
The end of repo rate hike?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
Apparently, the RBI is exasperated. After 18 months of inflation and 13 hikes in repo rate, RBI Governor Duvvuri Subbarao more or less admitted a day before Diwali that the pursuit of interest policy had gone far enough even though it hardly made any different to inflation and only deflated the growth rate instead. But he is not without hope.
The RBI believes that inflation will begin to decline from December, reach 7 percent by March and ease further in the first half of 2012-13. What has made the RBI indulge in these amusing predictions is not convincingly explained. Having been accused of pulling down growth, the RBI also expects that investment will pick up once inflation is pushed down, suggesting that a reversal of monetary policy will follow.
Undoubtedly, the RBI, like other central banks, is charged with the responsibility of maintaining price stability. For the RBI, inflation is the principal target of policy and interest rate the most preferred weapon. Three years ago in July 2008, India had inflation exceeding 11 percent and the RBI had kicked up the repo rate to 9 percent. In just three months, inflation took a plunge — not so much in response to the interest hike as from the impact of the world financial crisis in September of that year.
Besides, the inflation of 2008 was intrinsically different from the inflation of 2011. The earlier inflation originated in the industrial sector and did necessitate an interest hike to cool it down. The present inflation is largely due to supply deficit of select agricultural commodities. The RBI was fully aware that the present inflation required government intervention much more than its own. But the government wholly relied on the RBI.
The supply deficit is in respect of protein-rich foods like milk, pulses, fruits and vegetables, and meat and eggs. That reflects an ongoing change in people’s consumption pattern, from carbohydrates to proteins, induced mainly by improvement in incomes. No wonder per capita consumption of cereals has been static in the past 5 years. What is critical is that the demand-supply gap in these protein-rich foods has not narrowed and the RBI may not be quite right in presuming that inflation will decline from December and taper down in the first half of the next year.
Indications are that food inflation has become almost chronic. Even though supply is increasing, demand for select foods is increasing even faster, preventing inflation from easing. The repo rate can hardly make any difference to that demand. But supply can be increased much more if governments extend facilities to farmers like interest subsidy, improved seeds, etc. and create an environment for efficient marketing and reduction in distribution cost.
Is another hike in repo rate necessary?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
On March 17, the RBI will review the quarterly performance of the economy and readjust the repo rate. In the past one year the rate was jacked up seven times at 25 bps on each occasion from 4.75 to 6.5 percent. The target was inflation.
Obviously, even after 12 months inflation remained untouched by the repo rate though it created other expected but undesirable side effects.
There were two reasons why the attempt did not succeed. First, inflation was not caused by overheating of the economy and therefore could not respond to monetary policy. It originated in the agricultural sector. The worst hit were vegetables, fruits and meat. In the manufacturing sector inflation was mild and was caused mainly by the spread effect of inflation in the agricultural sector and higher international prices of industrial raw materials.
Second, the baby steps of 25 bps at a time did not create the shock effect that is necessary to curb demand. If the 175 bps increase had been made in a single sweep, perhaps the result, as far as inflation is concerned, would have been significant. However that would have caused serious dislocation which would have hit growth badly. For that reason, most central banks prefer to increase interest rates in small doses so that adjustments become easy.
The situation now seems to have significantly changed. Food inflation which had shot up to 18 percent in December has slowed down to single digits and may be back to normal in another month or so, pulling down headline inflation with it. Therefore further hikes in repo are not necessary particularly because the adverse side effects of higher interest rate are gathering momentum.
It is true that the repo rate is not the only reason for increase in interest rates across the board. There has been liquidity shortage. Credit has outpaced deposits. Further, the auctioning of 3G spectrum and divestment in public sector enterprises transferred 850 billion rupees to the RBI, though government borrowing became less aggressive.
