RATE CUT ENIGMA
Will there be a Rate Cut
or will there not be? Will RBI respond positively this time to everyone’s wish?
This has been an Enigma
for quite some time now. When rates were going up in last 3 years, there were
no doubts in anybody’s mind. Inflation was going up. Therefore, rates must go
up. This was and is an implicit assumption in everybody’s mind. These two are
linked indelibly, inevitably – because the Economics Theory says so. When
Inflation goes up, Rates must go up. But, if rates go up, will Inflation come
down? Really? Did it ever happen? Have any of us seen this happening?
Well. I haven’t seen this
happening. In fact, as rates went up, Inflation also went up further. Again,
rates were pushed up further. Again, Inflation went up further. Again, Rates
were pushed up further. This went on for almost 3-4 years in recent past. I
haven’t witnessed even once, the inflation responding to Rates.
Yes. Inflation was
seasonally coming down – when vegetable supplies increased. When crops
cultivation went up. But, never did the Inflation respond to Rates.
If at all there seemed to
be some correlation between the two, Inflation always went up when Rates went
up. It was a DIRECT RELATIONSHIP, not an inverse relationship. Why was this so –
when economic theory says otherwise?
I was always wondering
what on earth was happening because of the tussle between Rates and Inflation?
I strongly felt, that
there was probably – probably, but not definitely - a direct relationship between the two factors
but definitely not an inverse relationship. If there was an inverse
relationship, Inflation should have come down at some point when the Rates
finally touched the ceiling. Ceiling, I say, because, at present levels, our
Indian Rates seem to be at world No.1 Position. Is there any other developed or
developing country, which has this High level of rates? I don’t think so.
If lending Rates are so High,
they must definitely be High for fertilizer companies, seed suppliers, Pest control suppliers, equipment suppliers,
for Farmers, for Farm labourers and everybody down the line in agriculture, food
and food related Industries. So, all input prices must be going up in
the agriculture and food related activities.
So, will food prices go up
or down? They must go up. That, to me, seems absolute Logic! So, how will food
Inflation come down when rates go up? No way, Unless 3 things happen due to
extraneous factors.
(i)
Monsoons must be timely and sufficient;
neither more nor less; nor untimely.
(ii)
The cultivated Acreage must go up
significantly.
(iii)
Better food production techniques must be
adopted.
Due to all these 3 factors,
if Food production goes up significantly, and food supplies in the Market move
closer to demand or move beyond that.
Food prices never went
down until and unless these three things happened. They went up always,
unmindful of what RBI was doing with its Rates. Like now, when Kerala is
culling down all its chicken stock due to fears of Bird flu etc. Prices of
chicken may go up , prices of eggs may go up , but demand for chicken may come
down due to fears of Bird flu, but these are external factors to Rate Cuts. So,
whatever RBI might or might not do with rates, it will have no impact on
chicken and Egg prices.
If we look at Non-food
Inflation, we all know that manufacturing has been coming down. Production is
down. Capital assets building has slowed down very badly. Capital asset suppliers
are experiencing slow down. We don't see any Primary market issues at all.
Therefore, even future production capabilities are
becoming suspect. Therefore, prices of non-food articles can only go up, if
demand persists. Rate cut has no great influence on demand for products. It has
deep influence only on production. But, production is getting depressed due to
steep rates.
If Production is Higher,
economies of scale will bring down prices of products. That is not happening
because of higher lending rates. All that seems to be happening is – Cheap Chinese
products are dominating all Indian markets, wiping out Indian production and
Indian producers. Chinese lending Rates are LOW and Chinese are cutting the
rates even further. So, their product prices are quite low and comparatively,
Indian products are costlier. So Indian products are disappearing even from
Indian Markets, leave alone getting exported.
I am not saying that
lending rates are the only major criterion deciding final prices. Other prices such
as labour wages and other input costs are also factors. But, Lending rates are
one major enabling factor. In India, the lending Rates are very High.
Therefore, I strongly
feel, our lending rates must come down to the levels of the Chinese. In my
view, Inflation will not respond to it by going up. But, Growth will respond to
it by going up. If RBI brings down rates – not by 0.25% but even by 2% - it
will be healthy for both Inflation and for growth.
Will RBI oblige this time
around? This is the million Dollar Question. In any case, I strongly feel that, there should be
serious discussion on this Rates Vs Inflation Enigma. There should be fresh
thinking on the subject. India can't afford to Grow at the current abysmal Rate, when the Potential to Grow is Huge.
