Monday, May 14, 2012

Inflation and the RBI cutting Interest Rate
Last week we saw poor IIP numbers, which made a case for the RBI to cut the interest rate to give some boost to the sagging fundamentals of our economy. However, April inflation has come at 7.23% versus 6.89% in March, primarily driven by food items. I had discussed this issue here a number of time as how the RBI's policy of maintaining a high interest rate regime, is putting additional burden on the head of the farmers, increasing the price of their produce, in a rising demand environment. This is going to continue unless some efforts are made to give them loans at cheaper rates--I reiterate this issue again.
Now, there are two issues here, which I would like to point out: 
(i) RBI has indicated that it would not further tighten interest rate and would more or less maintain status-quo on the same in the recent meetings. If the headline inflation comes down further, it would further cut the Interest Rate. So, upside of the interest rate trajectory is capped, while there are more case for the downward revision of the repo/reverse repo rate. Also, bad IIP numbers, makes a case for a further cut in the interest rate.
(ii) Any rise in inflation, proves that the demand is still high in the Indian economy and the companies should make good profits, in the current scenario, unless, there is a huge supply side inflow. Moreover, certain sectors, needs to be boosted, where the growth is falling, rather than to look for overall-boost. For, example a cut in the interest rate is immediately necessary to boost the capital goods and infrastructure sector, which is are pillars of the Indian economy. On the other hand, the government could make a case for differential interest rate for various sectors, like Auto, which means we can continue to maintain high interest rate for buying cars, so that the investors postpones their decision, leading to demand destructions.
So, this essentially means, RBI will now have to cut interest rate on two grounds:
(i) Very dismal IIP numbers, leading to threatening of the GDP growth for FY13;
(ii) RBI is not able to tame the shooting-demand by interest rate hikes--in fact high interest rate is not helping anyone, neither the people nor the companies. Keeping interest rate for such a long time has, on the contrary harmed the Indian economy. So, it has to leave this stick and carrot policy and come to some realistic policy away from the books on classical economics.
Therefore, my standard suggestion for the government at this point of time, would be to cut the interest rate further so that, many projects in the infrastructure (Power/Real Estate) sector, becomes viable and at the same time farmers get loan at a cheap price to bring down the cost of their produce. 
On the flip side, the government as a corrective measure, could introduce new taxes to some sector, to tame the rising demand, which could restrict the flow of some of the extra-money in circulation and at the same time  help in addressing fiscal deficits.  In my opinion in such a scenario, the RBI has no option but the cut the rates and the government has no option but to increase a bit of the taxes. 
I know the pundits will say, that in a depreciating Rupee scenario, it would be dangerous to play with the interest rate, but then the currency devaluation is the effect of some other problem, which the government created artificially, and which needs to be addressed first. It means instead of taming the headache, we need to tame the cause which is causing the symptoms of headache.
Actually some inflation is positive for the bottomlines of the companies as they get more value of their products than during the recessionary times. So, in a constant interest rate environment (with a slight bias towards softer side), I think a slight rise in inflation is actually positive for the India Inc. We have already seen how the companies in the food processing space is making huge incomes, due to the rise in the food inflation. The time has come for the RBI to take some innovative steps rather than sticking their guns on the old theories and practices. Economics is a pseudo-science, and hence there can be lot of tweaking of the existing postulates and principles. Nifty is now trading at 4892, which should recover in the 2nd half of hte trade. I am expecting the Nifty to close above 4900, as there is no pressure from the RBI to go in for a rate hike. It could either cut the rates or maintain status quo.
Meanwhile, Sanguine Media Services Ltd has hit another buyer freeze, as the company embarks on restructuring, exercise. 

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