Tag: Repo Rate | Page 6

28 October, 2014

Jaitley again asks for interest rate cuts, needs lessons in basic economics

Vivek Kaul

It is fashionable in Delhi circles these days to ask for an an interest rate cut at a drop of a hat. The finance minister Arun Jaitley like his predecessor P Chidambaram likes to remind the Reserve Bank of India (RBI) now and then that the time is just right for a rate cut.
In an interview to The Times of India late last week Jaitley said “”Currently, interest rates are a disincentive. Now that inflation seems to be stabilizing somewhat, the time seems to have come to moderate the interest rates.”
Before Jaitley, the senior columnist Prem Shankar Jha became the newest interest-rate-wallah on the block and in a column in The Times of India held the RBI responsible for India’s slow economic growth over the last few years. As he wrote“[The] Indian economy is not on the road to recovery. The reason is the sustained high interest rate regime of the past four years. Industry has been begging for cuts in the cost of borrowing since March 2011… On August 5, RBI governor Raghuram Rajan surprised the country by announcing that he would not lower interest rates, because at 8% consumer price inflation was still too high.”
I guess Jha must have been among the few people surprised by Rajan’s decision given that among those who follow the workings of the Indian central bank closely, almost no one had expected Rajan to cut interest rates.
The premise on which interest-rate-wallahs work is that at lower interest rates people will borrow and spend more, which will lead to economic growth. But the entire premise that low interest rates will lead to a pick up in consumption and hence, higher economic growth, doesn’t really hold. (As I have explained here). Jaitley believes that “expansion in real estate will take place significantly only if the interest rates come down a little.”
This is what the real estate companies also like to believe. But the basic point is that people are not buying homes because home prices have risen way above what they can afford. As I have explained in the past, for an average Mumbaikar it currently takes around 34 years annual income to buy a home to live in. This is true for other cities as well, though the situation maybe a little better than that in Mumbai. So even a major cut in interest rates is not going to lead people buying homes to live in unless real estate prices fall. This is something that Arun Jaitley as the finance minister of this country needs to understand.
Having said that, those looking to move their black money around will always look at investing in real estate and for them the interest rates really don’t matter.
The other big reason offered is that companies can borrow at lower rates of interest. The idea being that lower interest rates might encourage companies to borrow and expand. Again it needs to be realized that companies don’t always decide to expand just because money is available at low interest rates, especially in difficult times as these.
Factors like ease of doing business and consumer demand play an important role. As I have explained in the past, due to many years of high inflation consumer demand in India continues to remain subdued. And unless it starts to pick up, there is no real reason for companies to expand.
Also, it is worth remembering here that a some of the major business groups in India have already borrowed a lot of money and are having tough time paying interest on the debt they already have. Hence, where is the question of borrowing more?
The bigger question that interest-rate-wallahs tend to ignore is how much control does the RBI really have over interest rates that banks pay their depositors and in turn charge their borrowers? Over the last few weeks, banks have cut interest rates on their fixed deposits. The list includes State Bank of India, Punjab National Bank and Central Bank of India. (You can read about here, here and here). The Indus Ind Bank also cut the interest it pays on its savings account to 4.5% from the earlier 5.5% for a daily balance of up to Rs 1 lakh, starting September 1, 2014.
All these cuts in interest rates have happened despite the RBI maintaining the repo rate at 8%. Repo rate is the interest rate at which the RBI lends to banks. So what has changed that has allowed these banks to cut the interest rates at which they borrow?
Let’s look at some numbers. As on October 3, 2014, over a period of one year, the loans given by banks rose by 9.87%. During the same period the deposits raised by banks rose by 11.54%. How was the situation one year back? As on October 4, 2013, over a period of one year, the loans given by banks had risen by 15.18%. During the same period the deposits had grown by 12.9%.
Hence, the rate of loan growth for banks has fallen much faster than the rate at which their deposit growth has fallen. Given this, it is not surprising that banks are cutting fixed deposit rates, given that their rate of loan growth is falling at a much faster rate.
As Henry Hazlitt writes in Economics in One Lesson “Just as the supply and demand for any other commodity are equalized by price, so the supply of demand for capital are equalized by interest rates. The interest rate is merely a special name for the price of loaned capital. It is a price like any other.”
As Hazlitt further points out “If money is kept…in…banks…the banks are eager to lend and invest it. They cannot afford to have idle funds.”
Hence, given that the rate of loan growth is much slower than the rate of deposit growth, it is not surprising that banks are cutting interest rates on their fixed deposits. Given this, the impact that RBI’s repo rate has on interest rates is at best limited. It is more of a broad indicator from the RBI on which way it thinks interest rates are headed.
Further, it also needs to be remembered that financial savings in India have fallen dramatically over the last few years. The latest RBI annual report points out that “the household financial saving rate remained low during 2013-14, increasing only marginally to 7.2 per cent of GDP in 2013-14 from 7.1 per cent of GDP in 2012-13 and 7.0 per cent of GDP in 2011-12…the household financial saving rate [has] dipped sharply from 12 per cent in 2009-10.”
Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc. It has come down from 12% of the GDP in 2009-10 to 7.2% in 2013-14. A major reason for the fall has been the high inflation that has prevailed since 2008.
The rate of return on offer on fixed income investments(like fixed deposits, post office savings schemes and various government run provident funds) has been lower than the rate of inflation. This led to people moving their money into investments like gold and real estate, where they expected to earn more. Hence, the money coming into fixed deposits slowed down leading to a situation where banks could not cut interest rates., given that their loan growth continued to be strong.
What also did not help was the fact that the borrowing requirements of the government of India kept growing over the years.
The RBI was not responsible for any of this. The only way to bring down interest rates is by ensuring that inflation continues to remain low in the months and the years to come. If this happens, then money flowing into fixed deposits will improve and that, in turn, will help banks to first cut interest rates they offer on their deposits and then on their loans.
The government needs to play an important part in the efforts to bring down inflation. In fact, it has been working on that front. In a recent research report analysts Abhay Laijawala and Abhishek Saraf of Deutsche Bank Market Research write that the “the government is firmly ‘walking the talk’ on fiscal consolidation” through a spate of “recent administrative moves on curbing food inflation (such as fast liquidation of surplus foodstock, modest single-digit hike in MSPs, an effort to eliminate fruits and vegetables from ambit of APMC etc.)”
This is very important given that once inflation remains low for an extended period of time, only then will inflationary expectations (or the expectations that consumers have of what future inflation is likely to be) be reined in. And consumer demand is likely to pick up after this.
The Reserve Bank of India’s Inflation Expectations Survey of Households: September – 2014 which was a survey of 4,933 urban households across 16 cities, and which captures the inflation expectations for the next three-month and the next one-year period. The median inflation expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent. Hence, inflationary expectations have risen since the beginning of this financial year.
To conclude, RBI seems to have become everyone’s favourite punching bag even though its impact on setting interest rates is rather limited. It is time that interest-rate-wallhas like Jaitley and Jha come to terms with this.

This an updated version of a column that appeared on Oct 22, 2014. You can read the original column here

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

30 September, 2014

RBI keeps repo rate at 8%: Lower interest rates are not a solution to slow economic growth

Vivek Kaul

Ramachandra Guha in a wonderful essay titled An Anthropologist Among Marxists writes about what he calls a “possibly, apocryphal anecdote.” As he writes “When Indira Gandhi was assassinated, her ashes were sent to different cities to allow public homage. When her ashes lay lay in Calcutta’s Government House they were visited one evening by the state’s finance minister. In the previous year this man had delivered no less than two hundred and sixty-two speeches on the discrimination against West Bengal in the release of funds from the central treasury. As the minister came out of the Government House, he was asked how he felt when confronting the mortal remains of his most resolute political opponent. He replied in character: Centre Kom Diye Che (the centre has again given us less than our rightful share).”
In another essay titled Political Leadership Guha writes “Jyoti Basu’s government, it was said, began every discussion on federalism with the words, “Centre kom diye che.”
The communists who ruled West Bengal for more than three decades liked to blame all the problems of the state on the central government, which they felt did not give the state a fair share of the funds.
Dear Reader, if you are wondering why am I talking about West Bengal and its politics in a piece which has the term “interest-rates” in the headline, allow me to explain. Over the last few years, everyone from politicians to businessmen to bankers have called for interest rates to be cut as a solution for reviving economic growth in India. The assumption is that at lower interest rates people will borrow and spend more and that will lead to economic growth.
In that sense, these individuals are not very different from the communist politicians of West Bengal for whom “Centre kom diye che” was an explanation for all the problems of the state. Along similar lines, individuals calling for a cut in interest rates seem to believe that higher interest rates are a major reason for the slowdown in economic growth, and a cut can really get people borrowing and spending all over again.
The former finance minister P Chidambaram was a major propagator of this belief. His successor Arun Jaitley has carried of where Chidambaram left. Other than the politicians, bankers have also regularly asked the Reserve Bank of India (RBI) to cut interest rates.
Today with the RBI deciding to keep the repo rate unchanged at 8% in the fourth bi-monthly monetary policy, the interest-rate-wallahs will be at it again. Repo rate is the rate at which the RBI lends to banks.
The RBI had its reasons for not changing the repo rate. As it pointed out in a statement “Since June, headline inflation has ebbed…The most heartening feature has been the steady decline in inflation excluding food and fuel…to a new low. With international crude prices softening and relative stability in the foreign exchange market, some upside risks to inflation are receding. Yet, there are risks from food price shocks as the full effects of the monsoon’s passage unfold, and from geo-political developments that could materialise rapidly.”
Nevertheless, over the next few days you will see bankers, real estate company owners, industry lobbies and possibly even the finance minister Jaitley, wondering why the RBI did not cut the repo rate, to get lending going again.
The most recent occasion when the interest-rate-wallahs came out in the open was when the bankers asked the RBI to cut the repo rate, after the growth in bank loans fell to a five year. As on September 5, 2014, the one year growth in bank loans stood at 9.7%. During the same time last year the number was at a significantly higher 17.9%.
The belief as explained earlier is that at lower interest rates people will borrow more. But as the American baseball coach Yogi Berra once famously said “In theory there is no difference between theory and practice. In practice there is.”
Lower interest rates do not always lead to more borrowing and revival of economic growth. An excellent example of this is what has happened in the aftermath of the financial crisis that broke out in September 2008. Western central banks brought down interest rates to very low levels in the hope that people will borrow and spend more, and help revive economic growth. But that did not happen. All it did was lead to many stock market bubbles all over the world.
Closer to home let’s take a look at car sales. The sales have revived from May 2014, after having continuously fallen for nine months. In August 2014, car sales grew by 15.16%, in comparison to the same period last year. This has happened without much change in interest rates. Why is that the case? Let’s try and understand this through a simple example. Let’s assume that an individual takes a car loan of Rs 4 lakh to be repaid over a period of five years at an interest rate of 10.5%. The EMI on this loan works out to around Rs 8,598.
Let’s say that interest rates were to come down by a massive 100 basis points (one basis point is one hundredth of a percentage)to 9.5%, all at once. At this interest rate, the EMI would work out to around Rs 8,401 or around Rs 200 lower than the earlier EMI. Now how many people will go and buy a car just because the EMI is now lower by Rs 200?
Anyone who has the ability to repay an EMI of Rs 8,401 can also repay an EMI of Rs 8,598. Hence, what people look at while taking on a loan is their ability to service the EMI. This involves at looking at factors like job prospects, the prospects of the company the individual works for and some idea of how he expects the broader economy to do. A major reason for the revival in car sales has been the election of Narendra Modi as the prime minister of India.
People have bought his election slogan “acche din aane waale hain” and hence, have taken on car loans and bought cars because for now they believe that their future will be better than their past. Interest rates have had no role to play in the revival of car sales.
Let’s consider real estate next. Here again the belief is that if interest rates are cut people will borrow and buy homes. This logic again doesn’t really hold. Home prices are now way beyond what an average Indian can afford. Let’s consider the city of Mumbai. A July 2014 report in The Times of India quotes Pankaj Kapoor of property research firm Liases Foras as saying “In Mumbai, the average cost of a flat is Rs 1.2 crore.”
An estimate made by Forbes puts the average income of a Mumbaikar at $5900 or around Rs 3.54 lakh (assuming $1 = Rs 60) per year. This means it would need nearly 34 years of annual income (Rs 1.2 crore divided Rs 3.54 lakh) for an average Mumbaikar to buy a home in this city currently. What this tells us very broadly that homes in Mumbai are very expensive. Similar calculations done for other parts of the country are most likely to show similar results.
Hence, the point is that homes in most parts of the country are now much more expensive than what most Indians can afford. Given this, lower EMIs because of lower interest rates aren’t going to help much. The real estate market has priced itself out.
This was the demand side of things. Now let’s look at what the economists call the supply side. Investments made by corporates have fallen rapidly over the last few years. As Sanjeev Sanyal of Deutsche Bank Market Research writes in a research report titled India 2020: The Road to East Asia and dated September 2014, “Gross Fixed Investment by the private corporate sector dropped from a peak of 14.3% of GDP in 2007-08 to 8.5% of GDP in 2012-13 (and likely even lower in 2013-14) with investments in machinery and equipment being particularly hit.”
The interest-rate-wallahs would like us to believe that this fall in investment has primarily been because of the high interest rates that have prevailed over the last few years. Nevertheless is that really the case? As Rahul Anand and Volodymyr Tulin write in an IMF Working Paper dated March 2014 and titled Disentangling India’s Investment Slowdown “Our results suggest that real interest rates account for only one quarter of the explained investment downturn. However, we find that standard macro-financial variables (interest rates, external demand, relative prices, global financial market volatility and others) do not fully explain the recent investment slump. Finally, using the new measure of economic policy uncertainty, the results suggest that heightened uncertainty and deteriorating business confidence have played a key role in the recent investment slowdown.”
Hence, if the current government really wants to get corporate investment going it needs to bring in a lot of much delayed structural reform. Also, it is worth remembering here that a some of the major business groups in India have already borrowed a lot of money and are having tough time paying interest on the debt they already have. Hence, where is the question of borrowing more?
Further, it also needs to be remembered that financial savings in India have fallen dramatically over the last few years. The latest RBI annual report points out that “the household financial saving rate remained low during 2013-14, increasing only marginally to 7.2 per cent of GDP in 2013-14 from 7.1 per cent of GDP in 2012-13 and 7.0 per cent of GDP in 2011-12…the household financial saving rate [has] dipped sharply from 12 per cent in 2009-10.”
Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc. The household financial savings were at 12% of the GDP in 2009-10. Since then, they have fallen dramatically to 7.2% in 2013-14. A major reason for the fall has been the high inflation that has prevailed since 2008.
The rate of return on offer on fixed income investments(like fixed deposits, post office savings schemes and various government run provident funds) has been lower than the rate of inflation. This has led to people moving their money into investments like gold and real estate, where they expected to earn more. If the household financial savings number has to go up the rate of interest on offer on fixed income investments needs to be higher than the rate of inflation. Only recently has the consumer price inflation fallen to levels below the rate of return available on fixed income investments. This situation has to be allowed to persist if the financial savings of India are to increase.
To conclude, calling for lower interest rates on almost every occasion is not a solution to anything. It is time the interest-rate-wallahs understand this.

(Vivek Kaul is the author of Easy Money trilogy. He tweets @kaul_vivek)

18 January, 2014

Why RBI is unlikely to cut interest rates later this month

Vivek Kaul
The business lobbyists want the Reserve Bank of India (RBI) to cut interest rates, now that the inflation for December 2013 has come down. “The easing of inflation at a time when industrial growth continues to be in the red should induce RBI to review its monetary policy stance and cut policy rates to rejuvenate growth, which has been hit by high interest costs, flagging investments and subdued demand,” Chandrajit Banerjee, the director general of CII said. Similar statements were made by other business lobbies as well.
There are multiple issues that need to be discussed here. Lets start with the inflation. The consumer price inflation(CPI) fell to 9.87% from 11.16% in November 2013. The wholesale price inflation(WPI) fell to 6.16% from 7.52% in November 2013.
A major reason behind the fall in inflation is the fall in vegetable prices. As per the CPI index, vegetable prices in the month of December 2013 fell by 18.4% in comparison to November 2013. In case of the WPI, the fall was greater at 29.7%. Onion prices fell dramatically by 42.4%.
Nevertheless, the prices of a lot of other food items continue to go up. As per the CPI index, prices of egg, fish and meat have gone up by 12.6% in the last one year. The price of milk products has gone up 9.87%. Cereal prices have gone up by 12.1%. Interestingly, the prices of these food items has gone up in December 2013 in comparison to November 2013. In fact, as per the WPI index the price of rice has gone up by 13.6% in the last one year.
If one looks at the overall category of food products, the prices declined by 0.6%(as per the WPI index) and 2.4%(as per the CPI index) between November and December 2013. Given this overall food prices continue to remain high. Also, if one takes the food and fuel prices out of the equation, the core consumer price inflation (CPI) in December 2013 was at 8%.
It is widely believed now that Raghuram Rajan, the governor of the RBI, is looking more at the CPI number while making policy decisions. As he had said in a statement dated September 20, 2013 “What is equally worrisome is that inflation at the retail level, measured by the CPI, has been high for a number of years, entrenching inflation expectations at elevated levels and eroding consumer and business confidence.”
Despite vegetable prices falling, the CPI number continues to remain on the higher side. If Rajan and the RBI continue to focus on the CPI number, it is unlikely that they will cut the repo rate any time soon. Repo rate is the rate at which the RBI lends to banks.
Even on the WPI front things don’t look too optimistic. Economists expect vegetable prices to continue to fall. But even with that they expect inflation to start rising again given that the prices of food items like rice are rising.
As Sonal Varma of Nomura Securities put it in a research note dated January 15, 2014, “Going forward, the correction in vegetable prices is still incomplete and should continue. However, with prices of other food items rising (such as rice) and base effects turning adverse, the expected fall in WPI in January-February should reverse again after March.”
As far as the industry lobbies are concerned they want the RBI to cut interest rates in order to revive industrial growth. The index of industrial production (IIP), a measure of industrial activity in the country, fell by 2.1% during the month of November 2013. The low industrial growth is also reflected in manufacturing inflation, which forms around 65% of the WPI index, and grew by a minuscule 2.6% in December 2013, in comparison to December 2012. In December 2012, the manufacturing inflation was at 5.04%.
What these low numbers tell us is the lack of consumer demand. People have been handling double digit consumer price inflation over the last few years. At the same time their incomes haven’t been able to keep pace with the rate of inflation. Food inflation has been been particularly high. A higher inflation also leads to the regular expenditure of people, as a proportion of income going up. Given this, they have had to cut down on expenditure on non essential items like consumer durables, cars etc, in order to ensure that they have enough money in their pockets to pay for food and other essentials.
This is reflected in the index of industrial production when seen from the use based point of view. The index number of consumer durables fell by 21.5% in comparison to November 2012. The index number of consumer goods, which has the highest weightage in the index, fell by 8.7%, in comparison to the same period last year. When the demand for goods is falling, it is but natural that there production will fall as well.
Hence, high consumer price inflation has been killing consumer demand. There is not much the RBI can do to control it, given that a major part of it is driven by a rise in food prices. At the same time, it won’t want to take the risk cutting interest rates, hopefully pushing up consumer demand and manufacturing inflation in the process. This will push up inflation further, and in the process build in more inflationary expectations into the system.
Also, it is worth remembering that the repo rate is at best an indicative rate. Even if the RBI were to cut the repo rate, it remains up to the banks whether they are in a position to pass on the rate cut to their consumers. The loan to deposit ratio of Indian banks as on December 27, 2013, stood at 75.2%. This means that banks have given out loans worth Rs 75 for every Rs 100 they had raised as deposits.
This ratio is on the higher side given that banks need to maintain a statutory liquidity ratio of 23% i.e. for every Rs 100 raised as a deposit they need to buy government bonds worth Rs 23. They also need to maintain a cash reserve ratio of 4% i.e. for every Rs 100 raised as a deposit they need to maintain Rs 4 with the RBI. Once this is factored in, the credit deposit ratio should not go beyond 73%. What this tells us is that banks have been borrowing from other sources at higher interest rates (in comparison to what they pay for deposits) to give out loans. In this scenario, the ability of banks to cut interest rates is rather limited.
Given these reasons, it is unlikely that the RBI will cut interest rates when it meets later this month on January 28, for the third-quarter review of monetary policy.
The article originally appeared on www.firstpost.com on January 17,2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)

18 December, 2013

Why inflation-fighter Raghuram Rajan did not raise the repo rate

Vivek Kaul
Raghuram Rajan, the governor of the Reserve Bank of India (RBI) surprised everybody today, by choosing to not raise the repo rate. The repo rate will continue to be at 7.75%. Repo rate is the rate at which the RBI lends to banks.
Economists had been predicting that Rajan will raise the repo rate in order to rein in inflation. The consumer price inflation(CPI) for the month of November 2013 was at 11.24%. In comparison the number was at 10.17% in October 2013. The wholesale price inflation(WPI) number for November 2013 came in at 7.52%. In comparison the number was at 7% in October 2013.
As Taimur Baig and Kaushik Das of Deutsche Bank Research wrote in a note dated December 16, 2013 said “The upside surprise in both CPI and WPI inflation for November leaves no option for RBI but to hike the policy rate(i.e. the repo rate) by 25basis points in Wednesday’s monetary policy review, in our view.”
Along similar lines Sonal Varma, India economist at Nomura, told CNBC.com that she expected the RBI to increase the repo rate by 25 basis points(one basis point is one hundredth of a percentage). But Rajan has chosen to stay put and not raise the repo rate.
Why is that the case? The answer lies in looking at the inflation numbers in a little more detail. The consumer price inflation is primarily being driven by food inflation. Food (along with beverages and tobacco) accounts for nearly half of the index. Food inflation in November 2013 as per the CPI stood at 14.72%. Within food inflation, vegetable prices rose by 61.6% and fruit prices rose by 15%, in comparison to November 2012.
So what this tells us very clearly is that consumer price inflation is being driven primarily by food inflation. In fact, this is something that the WPI data also clearly shows. The food inflation as per WPI was at 19.93%. Within it, onion prices rose by 190.3% and vegetable prices rose by 95.3%.
The RBI expects vegetable prices to fall. Baig and Das in a note dated December 18, 2013, said “vegetable prices, key driver of inflation in recent months, have started falling in the last couple of weeks (daily prices of 10 food items tracked by us are down by about 7% month on month(mom) on an average in the first fortnight of December).”
In case of WPI, food articles have a much lower weightage of around 14.33%. The other big contributor to WPI was fuel and power, in which case the inflation was at 11.08%. This is primarily on account of diesel and cooking gas prices being raised regularly in the recent past.
So inflation is primarily on account of two counts: food and fuel prices going up. The Reserve Bank of India cannot do anything about this. And given that raising the repo rate would have had a limited impact on high inflation.
In fact, if one looks at the WPI data a little more carefully, there is a clear case of the economy slowing down. Manufactured products form a little under 65% of the wholesale price inflation index. The inflation in case of manufactured products stood at 2.64% in November 2013.
When people are spending more and more money on buying food. They are likely to be left with less money to buy everything else. In this scenario they are likely to cut down on their non food expenditure.
And this has an impact on businesses. When the demand is not going up, businesses are not in a position to increase prices. And that is reflected in the manufacturing products inflation of just 2.64%. It was at 5.41% in November 2012.
Interestingly, the high cost of food should translate into the cost of labour going up. At the same time, energy prices are also going up. This is reflected in the fuel and power inflation of 11.08%. But businesses have not been able to pass through these increases in the cost of their inputs, by raising the price of their final products. This is primarily because of the lack of consumer demand.
The lack of consumer demand is also reflected in the index of industrial production(IIP), a measure of industrial activity. For October 2013, IIP fell by 1.8% in comparison to the same period last year. If people are not buying as many things as they used to, there is no point in businesses producing them.
In this scenario, raising interest rates would mean that people looking to borrow and spend money to buy goods, will have to pay higher EMIs. Businesses looking to borrow money and expand will also have to pay more. And this turn impacts economic growth. As the RBI’s statement today put it “The weakness in industrial activity persisting into Q3, still lacklustre lead indicators of services and subdued domestic consumption demand suggest continuing headwinds to growth.”
In this scenario the Rajan led RBI decided to keep the repo rate constant. What is interesting is that the RBI’s statement has suggested that it might raise the repo rate if the food inflation does not fall as it is expected to. “If the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the next round of data releases, or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted,” the statement said.
Effectively, the RBI has bought some time. “The RBI has effectively given itself a one-month window to see if inflation actually eases in December to decide on future monetary policy action,” wrote Baig and Das of Deutsche.
In fact, Raghuram Rajan’s decision not to raise the repo rate has been seen as a surprise primarily because he has made several comments in the public saying that inflation was running higher than the comfort level. Also, Rajan is seen as an inflation fighter, and by not raising the repo rate, he has put that image at risk.
As Robert Prior-Wandesforde, director of Asian economics research at Credit Suisse, recently wrote “The data pose the now familiar dilemma for the central bank. While the direct effect of interest rate hikes on inflation is debatable, particularly when food prices are such an important driver, we very much doubt Dr. Rajan can be seen to be sitting on his hands at this stage …”To do so, would be take risks with his inflation fighting credentials,” he added.
It is hard to believe that Rajan will these credentials at risk. And given that we might just see a repo rate hike early in the new year.
The article originally appeared on www.firstpost.com on December 18, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)

30 October, 2013

RBI rate hike: When Mauni baba takes onus for economic woes

Vivek Kaul
It was one of those rare days when Mauni baba had decided to talk.
“What man Chidu you send these guys to the Reserve Bank and suddenly they decide to have a mind of their own,” he told Chidu, who was busy thinking about new ways to send out income tax notices to tax payers.
“Yes sir. I had great faith in the professor. But the first thing he did was raise the repo rate,” replied Chidu.
“It is the R effect,” explained Mauni baba. “First Reddy, then Rao and now Rajan. All from the South of the Vindhyas. And I thought Sikhs were a rebellious race. You know sadda haq aithe rakh and all that.”
“Yes, the three Rs were so humble and docile while they were in Delhi,” said Chidu. “Wonder what happened to them as soon as they landed in Mumbai.”
“Next time we will appoint my man Monty to the post,” said Mauni baba. “At least he will listen to me and stay silent.”
“Yes sir. That sounds like a great idea,” remarked Chidu. “Madam will also like it.”
“Also, we should move the Reserve Bank to Delhi, then it will be easier to keep the governors under control.”
“Brilliant idea sir ji,” responded Chidu. “There is too much independence in the Mumbai air. ” “But Nana ji hasn’t Rajan done the right thing by raising the repo rate,” said Mauni baba’s granddaughter, who had suddenly entered the room.
“Arre beta,” said Mauni baba, looking lovingly at his granddaughter. “What do you know about all this?”
“Nana ji, you know na I am studying economics at the University of Chicago.”
“Oh, yeah, your mother told me, but given that I have a country to run, I keep forgetting,” replied Mauni baba.
“Really?” said the granddaughter. “But I just heard Chidu uncle telling someone on the phone that you only do what Madam asks you to do.”
“Arre beta. What are you saying? You must be mistaken. I did not say anything like that,” said Chidu, looking very embarrassed, as he got up from his chair.
“ Kya yaar Chidu. Sit down. Don’t worry. I have seen everything. I don’t get upset too easily,” said Mauni baba trying to reassure Chidu.
“So beta why do you think Rajan uncle has done the right thing?” asked Chidu, trying to divert attention from his gaffe.
“Uncle, one of my professors told us about Milton Friedman and his views on inflation. In fact, he quoted a paragraph out of Friedman’s book Money Mischief – Episodes in Monetary History.”
“And do you remember that paragraph?” asked Chidu.
“Oh yes I do. Like all good Indian students, I am good at ratta maar.”
“So what did Friedman write?” asked Mauni baba. “Tell us about it beta.”
““The recognition that substantial inflation is always and everywhere a monetary phenomenon is only the beginning of an understanding of the cause and cure of inflation…Inflation occurs when the quantity of money rises appreciably more rapidly than output, and the more rapid the rise in the quantity of money per unit of output, the greater the rate of inflation. There is probably no other proposition in economics that is as well established as this one,” is what he wrote,” came a long wielding response from the granddaughter.
“Wooh!” that was fantastic. What memory,” exclaimed Chidu. “Reminded me of Amitabh Bachchan.”
“Bachchan?” asked Mauni baba. “Wo kahan se aa gaya?”
“Sir. The little speech reminded me of what Bachchan once said.”
“What did he say?” asked Mauni baba.
“You see the whole country of the system is juxtapositioned by the hemoglobin in the atmosphere
because you are a sophisticated rhetorician intoxicated by the exuberance of your own verbosity.”
“What?”
“My name is Antony Gonzalves,” said Chidu, breaking into a jig.
“Shut up. The girl is trying to make a point,” said a rather irritated Mauni baba.
“Sorry sir.”
“Haan beta. So what were you saying?”
“Nanu, I just said that inflation is a monetary phenomenon, which means as the money going around in the financial system increases, so does inflation.”
“That’s right. And how can we control it?” asked Mauni baba, as the economist in him suddenly woke up.
“We can control inflation by raising interest rates.”
“And?”
“And the Reserve Bank has done the correct thing by raising the repo rate or the rate at which it lends to banks.”
“So?”
“At higher interest rates people will borrow lesser given the higher EMIs they will have to pay.”
“And how will that make a difference?”
“Since people will borrow lesser, they will spend lesser as well. This will mean that a lower amount of money will chase goods and services, and that will bring inflation under control.”
“Wow!” blurted out Chidu. “Another economist in the family.”
Mauni baba was impressed. But he had to tell her the truth.
“Well beta. This needs a little more explaining,” he told her.
“Please tell me, I am all ears,” said the granddaughter.
“In 2007-08 the government spent Rs 7,12,671 crore. This year the number is expected to be Rs 16,65,297 crore or 133.7% higher. This has led to more money entering the economy and chasing the same amount of goods and services and thus driving up inflation.”
“As Friedman said?”
“Yes. Exactly like that. During the same period, the fiscal deficit of the government has risen by 327% from Rs 1,26,912 crore to Rs 5,42,499 crore. Fiscal deficit, as you would know, is the difference between what a government earns and what it spends.”
“Yes. So?” asked the granddaughter.
“The government makes up for this difference by borrowing money. With the mammoth increase in fiscal deficit, it has had to borrow more and more. This has crowded out the private borrowers.”
“I know where you are getting at,” said the granddaughter with a huge smile on her face.
“Hence, every time Chidu uncle asks banks to cut interest rates on their loans, I have a good laugh, and so should you, from now on. With the government borrowing more, there is a lower pool of money for the private borrowers like banks to borrow from. Hence, they need to offer a higher rate of interest on their deposits. And this means a higher rate of interest on loans.”
“Interesting.”
“A large part of inflation has been because of food. In fact, half of the inflation over the last five years has been because of a rise in food prices. As per the latest wholesale price inflation numbers, the price of onion has risen by 323% in the last one year. Vegetable prices during the same period went up by 89.37%. Fruits were up at 13.54%. And all in all food prices were up by 18.4% in comparison to the same period last year.”
“So?”
“So the RBI cannot do anything about inflation. It does not matter if they hike repo rate or not,” explained Mauni baba. “Interest rates will not fall unless the government controls the fiscal deficit. And onion prices won’t fall unless Power Man wants them to.”
“So why don’t you just control the fiscal deficit Nanu?” asked the granddaughter.
“Well, that is for Madam to decide.”
“Beta, we are running many programmes for the poor. And that is why our fiscal deficit is high,” said Chidu.
“Yes, I know all about those subsidies. You offer subsidies to those who drive diesel cars and people who use cooking gas cylinders. Since when did they become poor?” asked the granddaughter.
“Not like that beta. We offer food subsidies to the poor.”
“Oh yes, I read about that Chidu uncle. You sell food through the public distribution system where more than 40% of the food gets siphoned off.”
“Beta, Madam has a vision for this country. You are too young to understand that, now you should go and let your Nanu and me discuss serious economic matters.” The granddaughter soon left the room.
“She will turn out to be an excellent economist one day,” Mauni baba said proudly with a big smile on his face.
“Well. And what was all that you were telling her?” asked Chidu, a tad irritated.
“What?”
“All this bit about the government being responsible for inflation and the Reserve Bank not being able to do anything about it.”
“Yes. Isn’t that how it is?”
“Madam, won’t like this.”
“Really?”
“I am going to go and tell her and the shehzada everything.”
“Yuvraaj bolo Chidu.”
“What you are not afraid if I go and complain to Madam?” asked Chidu, not being able to figure out how Mauni baba continued to be so jovial.
“No.”
“You might lose your job.”
“Chidu, I thought you were a smart man.”
“As in?”
“Well, what is my name?”
“Mauni baba,” said Chidu. “But what’s that got to do with this?”
“Are you really that dumb?” asked Mauni baba. “Well who is going to believe you when you go and tell them that I spoke for as long as I did.”
“Oh.”
“I think you have been spending too much time in Delhi. It’s time to go to Mumbai, Chidu,” said Mauni baba, having the last laugh.
The article originally appeared on www.firstpost.com on October 30, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)