Tuesday, January 24, 2012
Third Quarter Review of Monetary Policy 2011-12 - AN ANALYSIS - WELCOME STEP - TIME FOR REDUCING INTEREST RATES ALSO
Third Quarter Review
of Monetary Policy 2011-12
The RBI MONETARY POLICY REVIEWS are always full of enlightened FACTs and Figures and are a MUST READ for every one interested in the country’s economy .The Review on 24th, January,2012 was also one such. It was awaited by many in the country – for several reasons.
This Blog also had carried several articles urging that RBI must now BAT FOR GROWTH – leaving the tackling of Inflation to the Central and State Governments – whose Onus, it really is, in the circumstances obtaining in India.
The Keynesian Economics works in a fully monetized economy. But, in India, there is a huge parallel, BLACK economy (Black money) in circulation and that thwarts all measures by the RBI to contain Inflation. Moreover, India is also known to have huge counterfeit Notes – possibly from some of our great neighboring countries and possibly also from some internal sources. The rural India is largely uncovered by the banking system in any form. But, huge spending takes place there. When we look at our electoral battles, we clearly understand how our elected representatives fight elections – mostly on Black money. This is a Great scourge for India – and even the Election commissioner has pointed out this several times.
But, what are the Bank Funds used are and how are they generated? Bank funds are the white money in circulation (mostly) and these are used for LENDING to various sectors, priority sectors, agricultural sector, Industrial sector and so on.
In recent years, another phenomenon that has come into play is CREDIT CARDS – which create TEMPORARY CREDIT in the economic system – and this generates DEMAND disproportionate to CURRENT INCOME.
Therefore, INFLATION in countries like India is more an interplay of DEMAND for a PRODUCT and SUPPLY of a PRODUCT – and depends less on MONEY SUPPLY as such. If too much of money is chasing too few goods – yes, Inflation results. That phenomenon can be seen in stray cases – like the festive demand season, when, tradition demands purchase of a few things in larger numbers and traders push up the prices to take advantage of the situation.
This apart, pushing up prices happens usually due to increase in raw material prices, transportation costs, Taxation etc – all of which have a large element of Government’s own actions. Price increases may also happen due to Hoarding, lesser supply (due to lack of rains, raw materials etc ). Each product in market has a peculiar set of circumstances – which push up its prices.
In India, many products are Price sensitive – including basic food products. People purchase less of tomatoes and onions also – when prices go up – and increase their purchase, when prices come down. People don’t travel by AIR – because of HIGH FARES. Reduce the fares, many more will travel. But Air Fares are HIGH mainly because of FUEL COSTS determined by Govt PSUs, and TAXES of central and state Govts. Government has not taken any positive action to bring down these taxes and Fuel prices.
But, in all these, INTEREST COSTS ON BANK CREDIT plays almost NO PART.
In fact, Interest costs have not mattered much for inflation even in DEVELOPED COUNTRIES. The irony is we see LESS INFLATION, where INTEREST COSTS ARE LEAST. This is the world wide experience today. What pushes up prices is input costs and supply constraints. In a competitive market of suppliers – increasing prices is not easy. It happens, when Govt pushes up raw material costs , like that of oil, fuel, gas, Coal, rail freight and so on, on the one side – and uses those funds on NON-PRODUCTIVE SCHEMES like NREGS on the other.
RBI talks of hidden inflation on Oil prices etc – but remove those subsidies – we will see violent movements in oil prices and no one will ever know how to fix their product prices.
These Oil and Gas subsidies give some stability to the economy. These make Indian Products a little less costly than they will otherwise be – to compete in International markets.
All said – control of Inflation in Indian conditions rests with Governments – through their fiscal policy actions and administrative actions.
In my opinion – prices are not going UP or DOWN - because of REPO & REVERSE REPO RATES. If any thing, if interest costs go up for a producer, to that extent, he will have to jack up his product prices. That way, the exact reverse of what RBI is seeking to achieve happens. Also, if Interest costs to fertilizer / pesticide companies go up - their product prices will go up – and thereby to a certain extent, agri commodities prices may also go up. Here also, the reverse of what RBI seeks to achieve – may be happening. A critical analysis of end-to-end cause and effect sequence needs to be done – since, many factors have changed and many new factors have come in (like CREDIT CARDS) since the classical monetary theory.
But, evidently, RBI monetary Policy affects Growth. In that there can be no doubt. Capital Assets are created only - when the Return on capital exceeds the cost of capital by a reasonable margin. Else, all the entrepreneurial effort is considered waste. COST OF CAPITAL is directly linked to interest on the Bank Credit. Producers at least avail Bank Credit for creation of Capital assets – almost always. If they find Chinese Banks giving cheaper Credit, they go for Chinese Banks. If Indian banks are giving Cheaper Credit, they go for Indian Banks.
Thus, Bank Credit is an important Engine for GROWTH – though its utility in arresting INFLATION is highly suspect in present Indian conditions.
RBI can fuel Growth in a Big way – by making cost of capital cheaper. The return on capital depends on many factors – again the Government’s taxation, subsidy, fuel cost policy etc come into picture in determining Return on capital.
For example, if Airlines Industry in India needs to survive, they not only need cheaper credit to Buy aircraft and run them, but also, lower taxes, lower cost of fuel etc – both are needed to enable them to run efficiently and profitably.
Based on this discussion – I welcome the CRR Cut proposed by RBI. I also welcome the excellent logic put forth by RBI for promoting Growth. It has also indicated albeit indirectly, the Government’s own policy requirements for Inflation control and promoting Growth.
So, CRR cut is a great Welcome. It provides IMMEDIATE FUNDS for all banks – and Banks will be able to lend much more than last quarter – without raising additional Funds. Those, who have already raised additional funds – will now have surplus funds – and will need to aggressively go for lending – so that they do not keep idle funds in their coffers.
But, FUND AVAILABILITY is one factor needed for Growth. Interest Rates is an equally crucial factor. One understands RBI’s anxiety for controlling Inflation. But, Inflation is moving UP and DOWN – not based on bank Rates, but because of supply factors and input factors. Also, as pointed out earlier, Countries having least Interest Rates have very less Inflation. This is a pointer that Higher Interest rates do not control Inflation and lower interest rates do not fuel Inflation.
The request to RBI, therefore – is to REDUCE INTEREST RATES SIGNIFICANTLY - and go the whole hog in batting for GROWTH – by reducing repo and reverse repo rates by at least 2 % - to levels where they were an year ago.
All said – the CRR cut and the pointers in Monetary policy provide a welcome relief to the country.
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