Story Of The Week

Why the Rates may not yet be lowered by RBI…

Market is anticipating that due to factors like the fall in oil prices, sluggish growth, lower bond yields, fiscal consolidation etc., and the rate cut by the central bank is imminent. There is a chorus for a rate cut prompting Reserve Bank of India (RBI) Governor Raghuram Rajan to take action at the bi-monthly review of its monetary policy on December 2, 2014.

Following are the few factors that are indicating a reviving economy:

  • Retail inflation has softened by 23 basis points to a 14-month low.
  • Crude oil prices have fallen 20 per cent since the previous policy review on September 30.
  • Consumer Price Index (CPI)-based inflation rate has fallen 330 bps since last September.
  • CPI-based inflation was 6.46 per cent, the lowest since the launch of new series in January 2012
  • GDP growth has been forecasted at 5.4-4.9% this financial year, which is likely to go up to 6.5% in 2015-16.

Rising GDP has been a major factor contributing to the demand to lower interest rates. To understand this better, please watch the following video on Loanable funds interpretation of IS curve:

https://www.khanacademy.org/economics-finance-omain/macroeconomics/income-and expenditure-topic/is-lm-model-tutorial/v/loanable-funds-interpretation-of-is-curve

Why RBI is not going for a Rate Cut?

  • The price of some vegetables like potatoes may have inched up in October.
  • The consumer price index based inflation has decreased due to softening of food prices and falling oil prices.
  • The decline in inflation has not been due to a decrease in demand for the commodities but because of commodity prices, which could now move either way in the coming months, creating an uncertainty.
  • The US Federal Agency may increase the rates, which will lead to the capital outflows from emerging markets like India, putting pressure on their domestic currencies; the central banks would not like to drop their guard on inflation in such an environment.
  • The next factor is the global crude oil prices. A rate cut in December, if that happens, will implicitly assume commodity prices to remain soft throughout 2015. If energy prices move in the other direction, domestic inflation – where the prices of both petrol and diesel are deregulated – will quickly reverse. In a regulated environment, it is the fiscal deficit that absorbs the shock of an energy price increase. But when prices are set free, it is inflation where the impact is felt.

Market players and economists say that the RBI may choose to wait for two reasons, firstly for the new monetary policy framework to be put in place before reversing his policy stance and secondly, wait for the full impact of an interest rate hike by the US Federal Reserve to pass through before easing monetary policy.

If everything goes well, RBI may lower the rates by February, 2015, which may give a further impetus to the county’s growth.

 

 

 

 

References

[1] Moody pegs India’s GDP growth rate at 6% in 2016: Financial Chronical

http://www.mydigitalfc.com/news/moody%E2%80%99s-pegs-india%E2%80%99s-gdp-growth-rate-6-2016-088

[2] Market expectations of an RBI Rate Cut Too Early: JP Morgan

http://profit.ndtv.com/news/economy/article-market-expectations-of-an-rbi-rate-cut-too-early-jp-morgan-691292

[3] Five reasons why Rajan may not cut rate in December: Business standard

http://www.business-standard.com/article/finance/five-reasons-why-rajan-may-not-cut-rate-in-december-114110700044_1.html

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