Expert Zone
Straight from the Specialists
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.
Cost of a rate cut delay in India
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The RBI took the first step to ease monetary policy by reducing CRR by 50 basis points on Jan. 24. However, it postponed an interest rate cut, in spite of the advice by the special committee, only to confirm its reputation of being cautious. But excessive caution can also cost the country a pretty penny.
Since then, there have been further developments. Liquidity in the system has been drying up and the RBI has been using open market operations to buy government securities in exchange for cash. That helped maintain the yield on long-term government securities within narrow limits though on short-term debt, like treasury bills, the government had to pay higher interest.
In recent weeks, inflation has climbed down from 9.1 pct in November to 6.7 pct in January. But while the RBI had been quick to raise interest rates with every point increase in inflation, it has been hesitant to cut rates in spite of easing inflation.
The obsession with high rates is causing growth to suffer. Last December, growth in industrial production was a mere 1.8 pct. That was mainly because of the 16 pct fall in capital goods production which reflects the sharp decline in national investment. In July-September 2011, for instance, national investment y-o-y was down from 30.3 pct of GDP to 28 pct. The main reason for holding back investment and income was the sharp increase in interest rates.
Interest rates rose to 8 pct in July 2011 from 5.75 pct in July 2010. Broadly, the rise of 225 basis points in interest rates caused national investment to shrink by 621 billion rupees in the July-Sept quarter of 2011 leading to a GDP loss of 1.03 trillion rupees.
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 pct at the beginning of inflation to 8.5 pct now, the yield on 10-year government bonds moved in the range 8 – 8.5 pct. The RBI has been buying dollars or buying government securities to replenish liquidity. The full brunt of the rise in interest rates was borne by the private sector either by corporates on bank credit or by individuals on home or car loans.
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.
Two problems, one strategy for both RBI and the Fed
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The Reserve Bank of India and the U.S. Federal Reserve were confronted with two different problems but used the same monetary strategy for solution. Neither succeeded.
The RBI had to pull down inflation and raised the repo rate in eleven steps in eighteen months by 3.5 percent. The expectation was that the rate rise will curb demand and lower prices. What happened was entirely different.
Headline inflation is still over 9 percent, largely backed by inflation in food, mainly fruits and vegetables, meat and eggs. Interest rate made no difference to food inflation because no one buys food from money borrowed from banks.
But the RBI did succeed in curbing demand for a variety of other products. With the high interest rate, demand for housing declined and construction activity slowed down. With the high interest rate, demand for cars and trucks dropped and production became stagnant and would even shrink. With the high rate of interest many industrial projects became unviable and investment declined. And so on.
All in all, GDP growth in the second quarter was down to 7.7 percent from 8.8 percent y-o-y. This was precisely what the RBI was looking for. But it had also expected that, with lower growth, inflation would fall. That did not happen simply because inflation was not due to over-heating of the economy but shortfall in critical food supply.
The Fed was expecting exactly the opposite to be achieved with the same strategy. The rate of interest was drastically cut and the Bank poured in trillions of dollars to keep that rate in check, hoping that investment and consumption will revive and unemployment will be reduced. Neither took place.
The one-instrument orchestra
(Nipun Mehta is a veteran private banker with many years of experience across Asia. The views expressed in the column are his own and not those of Reuters)
The Reserve Bank of India on Tuesday quite unexpectedly raised interest rates by as much as 50 basis points. It was a move that shocked the street and took a lot of people by surprise. It was also a move showing aggressive intent at inflation management.
How is this announcement being viewed by the street? What are the implications of such a hike when interest rates were expected to have almost peaked?
It’s an accepted fact now that various efforts at inflation management have either been unjustifiably inadequate or completely missing. It’s also an accepted fact that much more than this being a demand-led inflation, this is a lack-of-adequate-supply led inflation or what is better known as inadequate supply chain management. Hence raising interest rates at this pace (11 times in the last 17 months) cannot achieve the kind of impact that improvement in supply through preventing hoarding or improving farm produce can.
To play good music one needs an orchestra with several musicians playing various instruments simultaneously. On the other hand what we have is the RBI alone trying to play its instrument and others (read the government) just watching in the hope that the lone musician will create the effect of an orchestra, and bring inflation under control. Merely raising interest rates will not bring down inflation fast enough.
With limited hope of inflation coming under control in the next quarter or two, one should expect more rate hikes in the coming months.
A couple of observations made by the RBI governor warrant a mention. His concern that meeting the fiscal deficit target could be a challenge, and the fact that economic growth had moderated but there is no economic slowdown. The latter observation is important as it is contrary to the observation made by several Bank heads as well as industry chiefs. If there isn’t an economic slowdown, this, and the subsequent interest rate hikes will ensure that. Importantly, the subsidy burden, the excise duty cuts, etc will ensure a higher fiscal deficit, and that can be inflationary too.
