Inflation is low so rate cut was due

Rajan stormed the media again today. When the most surveys expected a 25 bps cut, he unleashed the market spirits with a 50 bps cut. They say it is a pleasant surprise and term it as ‘Diwali Gift’. My opinion is different.

I have been writing on this blog that rate cut was due. Negative WPI and persistently coming down CPI were calling for rate cuts for few months in a row. But the cautious stance held by RBI was preventing the rate cut. Today Rajan let it a go. But still RBI says Inflation can come back to 5%. They are inflation hawks; controlling inflation is their first job. But what one has to note that is, it is not because RBI is cautious inflation is down. To get your facts right, please look around and take note. Inflation is down everywhere. Forget inflation, many developed countries are fighting deflation. Paul Krugman wrote a column on why inflation is good for his country. Many emerging countries and our Asian neighbors all have a lower inflation. Our rival China’s inflation is lower than 2%. When this is the situation and the trend, why India would behave entirely different? Global economic growth is down, so is inflation and interest rate. A normal course which India also catching up. So a 50 bps cut is not any gift and it was rather a delay in the roll out.

Now that RBI is again cautious in saying that inflation (CPI) can come back to 5%, they are most likely to be surprised with what the future holds. India is not overspending like Greece or over investing like China. We have our own issues but inflation situation is likely to ease further than flare up. This rate cut will help in improving the profitability at banks and much of their NPA which were on the edge are set to come back in green when the benefit is passed on to ailing debt laden corporate. Reducing capital costs will ease the pricing pressure across the board. Some of the inventory in housing can reduce with reduction in the EMI as fence sitters finally make their decision. When new houses are occupied, it will stall the rents from soaring which is a big component in CPI. E-commerce companies are giving away so many offers, all your household stuff can be bought at discount, forget the inflated prices. If you drive your own vehicle, you fuel bills are slightly lower than last year so they are not contributing to inflation. Food is a tricky part but monsoon was not bad. Onion prices calmed down as the hype did not last long. Supply situation has improved a lot in agriculture commodities. There is lot of physical infrastructure which has come up in the recent past and has to find utilization. So Schools and Hospitals can’t ask for moon like before as they are likely to lose their customers to their competitors as there are many new entrants. Food will be the only biggest component in CPI pack driving inflation up. Transportation is seeing a deflationary trend. All other components are staying where they are, neither inflation nor deflation. All in all, inflation is likely to remain at 4% and may go down below 4% too.

As inflation surprises the central bank of India, it will reduce the rates further. I will not be surprised if SBI offers a home loan at around 8% next year. It is not because of Rajan or Modi. I am not against them, but you cannot ignore the fact that luck is favoring them.

Interest rates are closer to zero in US. Though they are set to rise, it will go up very slowly. When savers there get nothing, why the borrowers in India will have to pay interest rates (bank rates) of above 10%? Will it not be fair to expect to have a real rate of 1%, (inflation at 4% and RBI rate at 5%) so that an efficient bank would lend it to retailers at 6% to 7% for long term borrowers like in the housing sector or to clean corporate? That will drive investments and infrastructure growth and turns India into an economic power house. There are so many households aspiring for a solid roof over their head. Why interest outgo has to be more than the principal in their loan period of 20 years? Many infra projects will become viable at lower capital costs.

I suppose though there is a delay, India’s destiny towards economic prosperity is not denied and today’s rate cut was a witness that we have not lost the way.