Thursday, November 27, 2014
RATE CUT ENIGMA - WHAT WILL RBI DO THIS TIME? - IS THERE REALLY AN INVERSE RELATION BETWEEN INFLATION & RATES?
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.