Monday, October 29, 2012





The Reserve Bank Of India is almost religious when it comes to handling INFLATION. This is traditionally considered one of the important functions of any Central Bank. The one weapon the Central Bank uses for inflation control is REPO & REVERSE REPO RATE HIKE. With the help of these rates, it seeks to monitor and adjust the liquidity in the Banking system, thereby control the credit and money flow into the economy – which is expected to impact on the Inflation by acting on the Demand side (Usually).

RBI has used it 13 times in very quick succession, when Inflation was climbing up the ladder from 2010 onwards.

Even as these Rate Hikes were happening, Inflation was galloping up faster; and did not seem to respond at all, to the Medicine that RBI was administering.

In my view, and this view I have said a few times earlier on this blog, INFLATION, especially the FOOD INFLATION part of Inflation (in Indian conditions) does not respond to the RBI RATE HIKES. It never did. If Inflation did ever come down it was due to SUPPLY SIDE easing and not because of Rate Hikes.

Even Inflation in Non-Food Products also has not responded to Rate Hikes.
So what did RATE HIKES actually do?

They hiked the Cost of capital for the entrepreneurs and they also hiked the cost of buying for buyers of goods. Thus, on one side, IIP was hurtling downwards and on the other side, many sectors were facing demand reduction and consequent production cuts. But, did it reduce the prices of those goods because of demand reduction? No way. 

Given the spiraling raw material costs – like minerals, oil, gas, coal, iron ore & other ores, electricity tariffs and so on -  there was no way, the prices of any manufactured  products could come down. Thus, whether it is core inflation or headline inflation, whether it is of food and food products or of non-food products – inflation was going up, despite Rate Hikes.

Even factoring in the lacunae which surface, time to time, in the compilation of the Basic data like IIP, yet, INFLATION, in general perception, was probably higher than what the INDEXES represented, not LOWER.

In the circumstances such as these, is it necessary to keep the REPO & REVERSE REPO rates at the current High levels? If so, for how long?

What if, Inflation climbs a few notches higher from current levels? Will RBI hike RATES again – or, keep them at current, already high levels?

It is beyond doubt now that GROWTH is adversely affected – and at least one of the major factors at work is the HIGH RATE STRUCTURE of the RBI.

From what Mr. stiglitz has said recently, and I totally agree with him,  GROWTH is much more important to be managed compared to INFLATION.

Many Industry leaders are clearly batting for RATE CUT. Even the Government  has thrown enough hints that it prefers a RATE CUT at this point of time. On its part, it has complied with some of RBI’s suggestions like Oil and Gas price hike, FDI approvals and so on. It is also working on Fiscal deficit. So, in the short run, what could be expected from Government at policy level, has been done. 

On the Food Inflation front, the concerned Ministries can of course do much more. It is meaningless for our Governments, both central and states, to be waiting for a Wal-Mart to come and construct storage spaces, proper transportation facilities and so on. Our Governments should be doing all this. Or, Governments should be giving sufficient incentives to Indian entrepreneurs to do these in a Big way.

This said, RBI’s stand on Food Inflation especially does not seem to stand the test of logic. If Repo & Reverse Repo Rates do not affect Food Inflation one way or the other – why keep the rates HIGH, because of food Inflation?

In my view, INFLATION in India reflects a failure to act – on the part of the Central and State Governments – not of RBI. They must act – not necessarily the RBI. If they don’t, RBI’s RATE ACTION will be pretty much useless. And, that is what is happening for last two years. But, no one can point an accusing finger at RBU for having not acted sufficiently to control Inflation. It has done its bit.

It was good on the part of RBI to point to the Government the need for  Government’s fiscal and administrative action to contain Inflation. RBI has stated explicitly about this need many times. Government must act on Inflation, leaving no stone unturned. That has not happened so far in any significant way – but it must happen at least now. Government has gone ahead with some good policy measures on the lines suggested by RBI, but much more needs to be done.

Given the present mood in the Government, this reform and fiscal consolidation process will continue further now.

So – where is the RATIONALE for keeping the REPO & REVERSE REPO RATES HIGH in this scenario?

CRR CUT is needed for enhancing liquidity in the system; this is true; but, more essential is the RATE CUT to spur Growth.

Bankers will need liquidity more and would welcome CRR Cut more. For them, RATE CUTS are almost revenue neutral. They can maintain their margins any way. With some rate-cuts, while margins will still be maintained by the banks at current levels, more borrowers may come to banks seeking credit.

On the other hand, for entrepreneurs and Buyers of goods, RATE-CUTS matter more. For entrepreneurs any reduction in cost of capital will mean greater incentive to invest in production. Since the rate of return will move up, growth will be more. This means, for Growth, Rate-cuts are more essential – even though CRR cut also is needed to ease the liquidity conditions.

It is therefore felt, RBI needs to strongly bat for GROWTH with both CRR Cut and a Rate-cut.

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