The GDP is seen at its 8 year low at about 5.5 % v/s a WPI inflation of about 7.6 which is not as bad as in comparison to the last 3 years. So the predominant question that surfaces is whether growth is the primary agenda or is it about curbing inflation? The RBI has been incessant on maintaining its stance on having lower headline inflation and thus having strong resistance in cutting down interest rates any further. The previous repo cut happened in April 2012 with the likelihood of it happening again on the 29-1-2013. The CRR rate was cut by a 25 basis point earlier this year. The normal notion lies that the CRR rate cut is followed by the cut in the repo rate.
However the question that still lies to be answered is how important is it to cut rates at this juncture. Will growth re-surface if the interest rate cut has been implemented? The fact that is intriguing is why growth was prevalent in the last three years when inflation kept rising. The several factors that could have led to a decline in growth is the high levels of corruption, higher subsidy bills, poor distribution channels, slower reform processes and the languishing pace of infrastructure . This contributed to growth plummeting and inflation rising. So to my knowledge unless these problems are rectified there is no scope of steady or increasing growth.
The next question that features is what are the ramifications of an interest rate cut? This will propel an increased corporate and retail borrowing, which will in turn lead to increased growth. Currently the government is only trying to curb expenditure but without increasing sources of revenue. The recent measures of divestment, rationalizing diesel prices (which do contribute to inflation) were some of its means to curtail expenditure .Hence it becomes imperative for new sources of income to be generated.
Printing of money will only lead to inflation. So productivity and supply side constraints are the main parameters that would be the primary agenda to limit inflation. However, there are certain factors like import bills of crude, gold and increasing real estate prices which is putting a massive pressure on expenditures and inflation. It is a known fact that India as a country charges a very nominal sum on its oil products in turn leading to losses for the oil companies and the government treasury. If crude products are rationalized and market demand –supply oriented then, it will contain or reduce expenditure.
The recent moves by the government seem to have ignited a certain positive sentiment in the market. It is evident that the government is compelled to act in perspective to the elections that are featuring in a year’s time. The FDI in retail and Aviation was essentially a strategic move to setting the economy in momentum and other the policy overhauls in mid September 2012 worked in the governments favor.
So again I come back to the question what is more essential growth or curbing inflation. What seems to be a graver problem? In my opinion, everything is linked. So if growth features in with the requisite productivity and streamlining of processes and reforms happens then inflation will wane off gradually to a decent level. Though the RBI is not wrong in resisting the rate cut, the prospects of growth versus that seems higher. Obviously the impediments and deterrents needs to be eliminated and investments on factors like infrastructure should be a priority to stay in tandem to the general growth.
Thus there has to be a balance in curbing expenditures and increasing revenues. Though the RBI would have its own reason, curtailing the fiscal deficit should be a priority as India has a problem of twin deficit which involves current and fiscal deficit which has to be the government’s primary concern. That generally leads to the Rating agencies downgrading our bonds and leading to a lesser inflows of FII money. We all know if that inflow was absent, then the depth of our market would have been a very shallow deal. And the 20 K Sensex currently would have stayed put at about 4-5 k (An approximate figure). Foreigners have purchased a net $18.7 billion of local shares this year, the most among the 10 Asian markets tracked by Bloomberg, excluding China. India's gross domestic product will increase 5.8% in the year through March 31, the Reserve Bank of India said on October 30, the slowest pace since 2003. This implies the consistent positive sentiments and growth prospects will have to sustain to attract investments from global arenas.
Thus if these reforms and measures sustain ,if the import bills and subsidy bills reduce and corporate earnings increase, then the rate cut is possibly a very good measure and reduced inflation will follow suit.
Source of Image :Economic Times.