Now that the February’2012 and January’2012 revised IIP numbers and the March’12 Inflation numbers are out the attention turns to the RBI policy on the 17th of April. As per Government data inflation is still stubbornly high at 6.9%.Notably food inflation is still very high at around 9.9%. February IIP growth came in at 4.1%.The very high inflation numbers under normal circumstances would not have allowed Mr. Subbarao to decrease CRR or the reverse repo rates. But these are not normal times are they?
Before diving into the pros and cons of a bank rate cut let us take a look at the Current Account situation.
The Current Account deficit has worried the Finance Minister so much that he had to raise the customs duty on gold. The merits of such a move are debatable. On the other hand with the Indian Rupee currently trading at around 51.30 to the US dollar means imported crude (80% of India’s crude oil is imported) has become more expensive apart from the fact that crude has at an average traded at $120 to a barrel (Brent crude) consistently in 2012.A growing current account deficit and erosion of our foreign exchange reserves is a worrying factor. If you reduce the bank rate and if it has a negative impact on inflation – which it might well have it would mean that the value of the rupee goes down further, this would mean that the rupee depreciates further against the dollar making crude oil imports even more expensive. This would in turn drive up inflation.
The government has till now shied away from increasing the administered price of fuel, but will not be able to hold on any longer. Oil Marketing companies are bleeding. Raising fuel prices is a double edged sword. On one hand by reducing subsidies it will help the Government to tide over the fiscal mess it has got itself into on the other hand, however, raising prices by reducing the Government subsidy will lead to higher inflation. Petroleum products are the highest taxed goods in India. Yet some of the petroleum products are also subsidised. An anomaly which is difficult to explain. To put it simply the taxes go into the Government coffers while on the other hand a large part of the subsidies are borne by Listed Government Companies. The Government does compensate the oil marketing companies but not 100%.
A further depreciation in the rupee would make things even worse.
A weaker rupee will make exports cheaper but the rise in input cost by way of rise in fuel would ensure that margins for exporters remain under pressure.
Further depreciation of the rupee would also make debt servicing by the Indian Government and the corporate sector more expensive. As an example if the Government had borrowed $10 billion dollars when the exchange rate was Rs48 for 1 dollar it had effectively borrowed Rs 48,000 crores. Now the rupee being 51.30 to a dollar means that the government will have to effectively pay Rs 51,300 crores in rupee terms an increase of 3,300 crores in around 6 months…..
It is against this back drop that Mr. Subbarao has to make the decision whether or not to cut CRR or the repo rate.
In terms of pure economics it is difficult to see Mr. Subbarao cutting rates. He has my support if he decides to remain firm and firm he must remain.
Thanks to the incompetent finance minister our “khazana” is near empty.
Privatisation of PSU’s have gone nowhere. Depending on LIC to bail out failed FPO’s or IPO’s will not work for ever. Spectrum auction should be seen as a one off receipt, expected to rake in Rs40,000 crore in FY’13 he must use it to reduce Government Debt instead of financing Air India and HMT restructuring.
On last count it is estimated that the Government will borrow Rs3,70,000 crores from the market in the next six months.
This will crowd out the market of liquidity and raise the borrowing cost of companies. Unless there is concrete action on the ground by the Government to reduce the budget deficit and rein in inflation the RBI Governor should not budge. The RBI has so far resisted pressure from the market to cut rates materially. This is a wise decision. Inflation has not gone down, infact food inflation has alarmingly gone up. Higher excise and service tax post budget would have a negative impact on inflation.This was done by the Finance Minister not the RBI. The RBI must not be held accountable for the follies of the Finance Minister.
Inflation in India is more a supply side phenomenon than a demand side. This means that the supply of goods and services has stagnated rather than the demand for them have quantitatively increased. If you decrease the bank rate what it will do is make borrowing cheaper for companies. This will make them invest to increase production which will increase supply of goods and services and this in turn will lead to lowering of prices. So much for the text book knowledge. India’s inflation is driven by increase in food and fuel prices and soon to be - rise in excise and service taxes. Rise in food prices unfortunately has to do more with black marketing, hoarding ,archaic laws and inefficient supply chain rather than pure economics. Hence if we want to see an increase in the supply of veggies ,pulses, cereals ,fruits and protein to the market tinkering with the bank rate will be of little use. What experts and commentators also miss out is that large Indian companies have huge cash and cash equivalent lying in their balance sheet, why would they then go in for market borrowings?
The moderate IIP numbers and the slowdown in the economy seems to be be attributed to the very high interest rates. Although interest rates do play a very important role in the growth of the economy, what is required now is heavy doses of sensible economic reforms.Bank rate’s by their own can not change the course of India’s slowing economy. Without pragmatic economic policies backed up by implementation it will be difficult to increase the economic growth rate and rein in inflation.
The tone of the RBI’s post policy notes clearly places the ball in the Government’s court to rein in inflation by reducing the budget deficit. At best tomorrow’s RBI policy will lead to a reduction in the repo rates by 25 bps.Let us see what is in store for us.
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