No Cut in Rates? Will Rajan Bite The Bullet?

November 21st, 2014
in Op Ed

Written by Sunil Chandra

All the Clamor for a Rate Cut...

As he gets ready to present the Fifth bi-monthly Monetary Policy Statement, Governor Rajan must be wondering about the clamor for an interest rate cut from all corners of the country.

Follow up:

When we say clamor, we refer to the loud noises being made by:

(i) the Media including all the experts each of whom happens to know more about the Indian economy than anybody else in the country;

(ii) the Government Officials, in general, and the Finance Minister in particular - who really would know more about the Indian economy than anyone else;

(iii) the sundry Fund Managers with their superior knowledge about the Indian economy who have bought so many bonds that any failure on Mr. Rajan's part to cut rates would place their portfolios in a real stink;

(iv) the Industry (and Industrialists), who actually make the Indian economy run, with their confidence that surely the Governor will not be obdurate and refuse to take the obvious hints from all around; and

(v) and , finally, the Great Indian Public whose knowledge about the Indian economy is unmatchable as they have diligently accepted all the one-sided opinions.

Incidentally, the last mentioned Public comprises of less than 3% who are actually Home Loan borrowers and over 60% who would be badly hit by an imminent fall in the Rates on savings.

Why all this Clamor.....

The demand has come because the wholesale inflation (WPI) has fallen to historic lows while the retail inflation (CPI) too has gone much below the Governor's stated target for the fiscal 2014-15. With Oil prices standing at just below US$ 78 per barrel, the decision to lower rates would appear to be a no brainer. Also, the economy is still functioning below the desired levels with very poor GDP growth and low growth in Industrial production. So the general consensus all around is "Go ahead Guv". In fact, why wait for another fortnight. Do It Now.

So is it really a no-brainer....

Why has Mr. Rajan kept silent through all this noise? Why has he not come forward with his take on the scenario? Why has he not actually accepted all this wisdom and reduced key policy rates and ratios? What can happen between now and December Second that could upset all calculations? To understand his apparent concerns, let us venture into the territory uncharted by most of the experts !!

  • Firstly, it is the weakening local currency. The Indian Rupee has fallen by nearly 4% against the mighty US Dollar in the past few weeks. The fall continues unabated despite the money flows from abroad. It is feared that the day when the 65 Rupee mark may be tested is not far. The classic currency defence of all central bankers is, of course, to increase rates and not decrease rates.
  • Secondly, the oil prices have yet to stabilize at the current low levels and corrective action from OPEC block may come sooner rather later. Further, the Government, in all its wisdom, has decided to take away a significant part of the price fall by increasing excise on petrol and diesel even though the duty was not on ad valorem basis and the fall in international prices was really not hurting its budget. Therefore, further impact of fuel prices on the CPI is likely to be minimal until oil prices fall further.
  • Thirdly, while funds continue to flow into markets unabated through the FII route, there has been no significant rise in FDI inflows in the past few months. So the current exuberance in financial markets could still be stunted by any sudden movement of the hot money.
  • Fourthly, the base effect of very high prices of certain key items in the last year's Price Index may have been responsible for some of the sharp fall now. Are these lower prices sustainable? Would they effect production of the same items in the highly sensitive farm sector in the next season? We have to wait and watch.

The increase in demand for gold imports by almost 300% is a cause for concern. Action by the Government (and, perhaps, by RBI), is inevitable. What would be the impact of such action on local and forex money markets would need to be seen.

The rate of Savings (and Investment) in the country is already at a decade's low level of around 30%. Any cut in key policy rates by RBI would also result in reduced rates on Savings and a perhaps, a further slowdown in Savings (and Investment).

What could happen on December 02...

Well, the impeccable Rajan Sir has really got his task cut out for him, with so many contradicting inputs. Surely, under the circumstances, the RBI Governor is likely to be extremely cautious (after all, has he not repeatedly stated that his aim is to throttle inflation, once for all?!).

He may well decide to hold rates and promise an early cut soon after all the indices have settled down. Or he may venture out(bravely yet fearfully), to satisfy the hunger of the clamorers by giving a small quarter point reduction in repo rates and then promise to review again in April of next year. Either way, it is unlikely to be a bigger cut than this.

You cannot throttle inflation permanently by knee jerk reactions.

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