HN: Retail inflation at 3-yr low: Reasons why RBI chief Rajan is not cutting borrowing rates
Everybody seems to want the RBI governor to a hit a six. But Raghuram Rajan is happy to play a defensive stroke because his main objective is to guard the wicket. Lest a wrong turn stumps him.
If you think, that isn’t cricket you have to understand the relationship between inflation and interest rates.
Shunning cat calls from industry and Parliamentarians, to cut interest rates, Rajan has quite bluntly has said that his mission in the stately RBI headquarters in Mumbai’s Mint Street , is not to attract Facebook `Likes’, and anyway since his famed prediction about the impending global crisis of 2008, is known to called a spade a shovel.
With inflation plunging to multi-year lows, the average citizen, business leaders, economists and politicians all seem to be asking the same question: Why hasn’t Rajan cut borrowing rates?
“I had taken a loan of Rs. 54 lakhs in 2006 to buy a house in Noida. I was comfortable with a monthly EMI of Rs. 48,000 at that point in time. Now the EMIs stand at Rs. 64,000. It is hurting me badly,” said Sudhir Verma an independent Delhi-based marketing consultant.
The RBI uses monetary tools to stymie demand and cool prices.
In times of weak growth and low prices, it is usually expected that the central bank will cut interest rates to goad companies to invest, add capacities, hire more, and prompt people to spend on houses, cars and other goods.
Retail inflation is at a three-year low of 4.38%, wholesale inflation at a five-year low of 1.77%, and overall economic growth at just above 5%. The RBI, so the argument goes, should cut lending rates that will lower EMIs, spur consumer purchases, cut companies’ borrowing costs and aid investment.
Rajan probably is worried that he should not be lulled into any kind of a false comfort zone as low inflation could be fleeting. He would rather wait than being fooled into dropping the guard on price control.
This is partly because of a statistical phenomenon called the “base effect”. Onion retailed at about Rs. 80 a kg this time last year compared to about Rs. 40 a kg now, showing a fall of about 100%.
There could be yet another reason: the rupee has fallen to a 9-month low of Rs. 62.33 a dollar on Thursday, could slide further if the US Fed Reserve, in a meeting next week, decides to raise interest rates from next year.
Higher yields could prompt funds to move closer home to the US; the dollar outgo will hurt the rupee, unless rates here are high enough for foreign funds to match returns in the US.
A weak rupee will fan inflation by raising prices of imported goods including oil, gadgets and mobile phones.
Also, costly loans may not be the only reason holding back investment. If companies aren’t adding capacities, it may also be because of low demand for their goods as people aren’t spending enough.
His unwavering focus to keep inflation firmly bottled up has evoked unusually caustic comments from politicians, who hit out at the Rajan’s hawkish stance, mirroring growing differences between Parliamentarians and the central bank.
Industry leaders think the conditions cannot be more benign for lowering loan rates.
“There could not have been a more favourable time for an interest rate cut with low energy prices, the currency stable and inflation falling. Rajan could have been a little more courageous,” a top business leader told HT requesting not to be identified.
Analysts said that the RBI is guided more by inflation adjusted “real” interest rates. The repo rate—the rate at which RBI lends to banks—8% and retail inflation at 5.5% implies a real interest rate of about 2.5%.
“We believe that the central bank will follow a framework of keeping positive real rates to the tune of about 1.5-2%. The key determinant of the magnitude of rate cuts will be where inflation settles on a sustainable basis,” Morgan Stanley, an investment bank, said in recent research report.
Finance Minister Arun Jaitley said he agreed with the call for lower rates but added that the final decision was for the monetary authority, the RBI.
"In spite of inflation easing, interest rates have not been cut. There has been no spurt in manufacturing activity. I suppose, Mr Jaitley is helpless in the face of an economist governor of the Reserve Bank of India," TMC MP Saugata Ray had said in Parliament. Congress leader Veerappa Moil also echoed similar opinion.
