Monday, August 24, 2015

Well-deserved rate cuts and is RBI reading it wrong?

I have been a great admirer of RBI and its chief Raghuram Rajan. But in the recent past it looks like they have misread the situation. Look at this article from Money Life which opines how Rajan’s stance is working against our economy.

Thanks to that article. I went back to my observations and put them together here.

o   In the recent meeting, RBI was expecting inflation (CPI) to be above 5%. But the actual data turned out to be 3.8%. Thanks to persistent lower prices in crude oil, its benefits are spilling out. But this was no complex data. It looks strange that RBI missed it by a large margin.

o   RBI started buying dollars when Rupee was trading at 58-60. They said it is to control volatility. Though forex reserves ballooned, it did not help curb volatility. Now Rupee is 66, more than 10% fall in valuations in just few months. It sounds like RBI’s intentions are to have a weaker Rupee and kill any strengthening symptoms by buying the dollar and selling Rupee. In other words, RBI is importing the dollars helping to weaken the Rupee. Though oil is down, what will happen to other imports like electronics when Rupee is weaker? Those importers will have to pay a higher price for the same amount of goods they buy. When Rupee is weak, how is it going to help reduce inflation?

o   Last week RB announced transferring a surplus Rs.65,896 crores to Govt. It was 25% more than last year. How did it make those additional profits, though its primary aim is not to make profits? RBI’s lends the money it create to banks and its profits rise when the base rate is high. There was a case for RBI to reduce rates instead of generating additional profits. Lower rates would have improved NPA situation. But being an inflation hawk, RBI did beat up the demand side of economy by keeping the rates high. Though it has reduced 75 bps so far, there was potential for more.

o   When Central Banks all over the world are trying to stimulate their economy by keeping rates near to zero why RBI has to keep the rates high? Even if it wants to have real rates to be positive, why it has to be 2% more than inflation? When the economy was bleeding why act like a vulture? To watch cautiously how the businesses will die?

o   Now inflation is in the range of 4% to 5%. Even if RBI wants to have 1.5% real rates, the base rate could be 6.5% in the worst case. Keeping themselves in the comfort zone, there is potential to decrease rate by another 75 bps.

No one questions RBI’s integrity or smartness. But being too cautious and playing too safe may not help the economy anyway.