The
challenge before RBI governor Raghuram Rajan: To cut or not to cut :-
The battle lines have been drawn. Before the next monetary policy announcement on 2 December by the Reserve Bank of India (RBI), both the government and businesses are stepping up the pressure on governor Raghuram Rajan to cut rates. The sharp declines in both the consumer and wholesale price indices have added to the pressure.
The arguments for a rate cut :-
1. Wholesale price inflation at 1.8%, the lowest in nearly five years and down from 6.2% in May.
2. Consumer price inflation at 5.5%, down from 8.3% in May.
3. Core consumer price inflation at 5.9%, down from 7.7% in May, indicating lower pricing power by businesses. Core wholesale price inflation at 2.5%.
4. International commodity prices have fallen dramatically, the consequence of a sluggish world economy and a slowdown in China.
5. Brent crude prices have fallen to below $80 a barrel and the International Energy Agency (IEA) predicts prices will slip further in the first half of 2015.
6. Rural wage growth has slackened.
7. Hikes in minimum support prices for agricultural produce have been modest.
8. The government is embracing austerity to keep the fiscal deficit down.
9. Farm prices have been stable despite a not-so-good monsoon.
10. Consumer goods output continued to contract in September, going by the Index of Industrial Production (IIP) numbers.
A rate cut will boost consumption and housing demand. Spare capacity will ensure that this does not translate into price increases. Improvement
in housing demand will boost construction, which will mean jobs for the masses.
11. Real interest rates are now positive. State Bank of India (SBI) chief economist Soumya Kanti Ghosh says real interest rates should be lower during a slump than during a boom.
The arguments against a rate cut: :-
1. The dramatic fall in inflation is due to the base effect. The picture may change early next year.
2. Inflationary expectations continue to be elevated.
3. There have been no structural changes in agriculture, necessary for increasing production and curbing prices. Food prices have fallen due to seasonal factors and they may go up again. Rural wages, too, may rise once growth returns.
4. Crude oil prices may move up again.
5. The government may want to curb the fiscal deficit but the slowdown will reduce receipts.
6. The kharif crop has not been good.
7. Rajan has said he wants to ensure that the fight against inflation is won decisively before he eases monetary policy.
8. It may be better to wait for the new monetary policy committee and the decision on the inflation target.
9. With the US set to raise interest rates early next year, India must wait and watch before a rate cut.
What RBI said in its last policy statement:
1. “Turning to the medium-term objective (6% by January 2016), the balance of risks is still to the upside… This continues to warrant policy preparedness to contain pressures if the risks materialize. Therefore, the future policy stance will be influenced by the Reserve Bank’s projections of inflation relative to the medium-term objective (6% by January 2016), while being contingent on incoming data.”
2. Base effects will also temper inflation in the next few months only to reverse towards the end of the year. The Reserve Bank will look through base effects.
What does the market say?
The rates for 1-year overnight indexed swaps (OIS) have come down from 8.5 in early August to 8%. That corresponds to expectations of around a 50-basis points fall in the repo rate over one year. One basis point is one-hundredth of a percentage point. The rates for 3-month OIS haven’t changed much, indicating the market is not expecting a rate cut soon.
Inflation rates earlier when the repo rate was 8%
The last time the repo rate was cut to 8% was in April 2012, when wholesale price inflation was 7.5% and Consumer Price Index was at 10.3%. It’s clear now that that decision was premature. A better example may be March 2002, when it was cut to 8% from 8.5%. Wholesale price inflation in March 2002 was 1.8%, precisely the same level as it is now.
An RBI working paper by Sitikantha Pattanaik and G.V. Nadhanael in 2011 found, “RBI’s inflation objective of containing the inflation perception in the range of 4-4.5% is consistent with the need for balance between ‘growth maximizing threshold inflation’ of about 6% and ‘welfare maximizing low inflation’ objective.” Note that this is Wholesale Price Index inflation, which has remained below 6% since last June.
There isn’t really much of an argument. If inflation rates remain near current levels in March, after the base effects are out of the way and the way ahead becomes clearer after the next national budget, almost everybody says RBI should cut rates sharply. Gaurav Kapur, senior economist at Royal Bank of Scotland, Mumbai, says RBI could narrow the corridor and keep the reverse repo rate nearer the repo rate, if it is concerned about excess liquidity leading to the effective policy rate suddenly slumping to 7%.
But the key point is Rajan should cut only when he’s confident he will not have to reverse course, frittering away hard-earned inflation-fighting credibility. He must not do a Subbarao.
PRATIMA KUMARI
PGSM 3rd semester
2013-15
The battle lines have been drawn. Before the next monetary policy announcement on 2 December by the Reserve Bank of India (RBI), both the government and businesses are stepping up the pressure on governor Raghuram Rajan to cut rates. The sharp declines in both the consumer and wholesale price indices have added to the pressure.
The arguments for a rate cut :-
1. Wholesale price inflation at 1.8%, the lowest in nearly five years and down from 6.2% in May.
2. Consumer price inflation at 5.5%, down from 8.3% in May.
3. Core consumer price inflation at 5.9%, down from 7.7% in May, indicating lower pricing power by businesses. Core wholesale price inflation at 2.5%.
4. International commodity prices have fallen dramatically, the consequence of a sluggish world economy and a slowdown in China.
5. Brent crude prices have fallen to below $80 a barrel and the International Energy Agency (IEA) predicts prices will slip further in the first half of 2015.
6. Rural wage growth has slackened.
7. Hikes in minimum support prices for agricultural produce have been modest.
8. The government is embracing austerity to keep the fiscal deficit down.
9. Farm prices have been stable despite a not-so-good monsoon.
10. Consumer goods output continued to contract in September, going by the Index of Industrial Production (IIP) numbers.
A rate cut will boost consumption and housing demand. Spare capacity will ensure that this does not translate into price increases. Improvement
in housing demand will boost construction, which will mean jobs for the masses.
11. Real interest rates are now positive. State Bank of India (SBI) chief economist Soumya Kanti Ghosh says real interest rates should be lower during a slump than during a boom.
The arguments against a rate cut: :-
1. The dramatic fall in inflation is due to the base effect. The picture may change early next year.
2. Inflationary expectations continue to be elevated.
3. There have been no structural changes in agriculture, necessary for increasing production and curbing prices. Food prices have fallen due to seasonal factors and they may go up again. Rural wages, too, may rise once growth returns.
4. Crude oil prices may move up again.
5. The government may want to curb the fiscal deficit but the slowdown will reduce receipts.
6. The kharif crop has not been good.
7. Rajan has said he wants to ensure that the fight against inflation is won decisively before he eases monetary policy.
8. It may be better to wait for the new monetary policy committee and the decision on the inflation target.
9. With the US set to raise interest rates early next year, India must wait and watch before a rate cut.
What RBI said in its last policy statement:
1. “Turning to the medium-term objective (6% by January 2016), the balance of risks is still to the upside… This continues to warrant policy preparedness to contain pressures if the risks materialize. Therefore, the future policy stance will be influenced by the Reserve Bank’s projections of inflation relative to the medium-term objective (6% by January 2016), while being contingent on incoming data.”
2. Base effects will also temper inflation in the next few months only to reverse towards the end of the year. The Reserve Bank will look through base effects.
What does the market say?
The rates for 1-year overnight indexed swaps (OIS) have come down from 8.5 in early August to 8%. That corresponds to expectations of around a 50-basis points fall in the repo rate over one year. One basis point is one-hundredth of a percentage point. The rates for 3-month OIS haven’t changed much, indicating the market is not expecting a rate cut soon.
Inflation rates earlier when the repo rate was 8%
The last time the repo rate was cut to 8% was in April 2012, when wholesale price inflation was 7.5% and Consumer Price Index was at 10.3%. It’s clear now that that decision was premature. A better example may be March 2002, when it was cut to 8% from 8.5%. Wholesale price inflation in March 2002 was 1.8%, precisely the same level as it is now.
An RBI working paper by Sitikantha Pattanaik and G.V. Nadhanael in 2011 found, “RBI’s inflation objective of containing the inflation perception in the range of 4-4.5% is consistent with the need for balance between ‘growth maximizing threshold inflation’ of about 6% and ‘welfare maximizing low inflation’ objective.” Note that this is Wholesale Price Index inflation, which has remained below 6% since last June.
There isn’t really much of an argument. If inflation rates remain near current levels in March, after the base effects are out of the way and the way ahead becomes clearer after the next national budget, almost everybody says RBI should cut rates sharply. Gaurav Kapur, senior economist at Royal Bank of Scotland, Mumbai, says RBI could narrow the corridor and keep the reverse repo rate nearer the repo rate, if it is concerned about excess liquidity leading to the effective policy rate suddenly slumping to 7%.
But the key point is Rajan should cut only when he’s confident he will not have to reverse course, frittering away hard-earned inflation-fighting credibility. He must not do a Subbarao.
PRATIMA KUMARI
PGSM 3rd semester
2013-15
The challenge before RBI governor Raghuram Rajan: To cut or not to cut
Read more at: http://www.livemint.com/Money/5PGOLbZ6qjoi4xfvqY8HMO/The-challenge-before-RBI-governor-Raghuram-Rajan-To-cut-or.html?utm_source=copyThe challenge before RBI governor Raghuram Rajan: To cut or not to cut
Read more at: http://www.livemint.com/Money/5PGOLbZ6qjoi4xfvqY8HMO/The-challenge-before-RBI-governor-Raghuram-Rajan-To-cut-or.html?utm_source=copyThe challenge before RBI governor Raghuram Rajan: To cut or not to cut
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