There is only so much that the RBI can do

Jan 24, 2012

In this issue:
» RBI cuts CRR, policy rates unchanged
» Europe to launch an objective credit ratings agency
» Stiglitz questions the effectiveness of austerity plans
» 600 m new jobs required in the next 10 years
» ...and more!

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At a time when inflation in India was reigning high, the Reserve Bank Of India (RBI) responded by resorting to 13 successive rate hikes since March 2010. This did not do much in terms of bringing inflation down drastically but instead slowed down the growth of the Indian economy. Weakness in the global economy also piled on the pressure. Now with the central bank worried about how growth will pan out, there are hopes that more rate cuts will be on the cards. But will rate cuts be enough?

In the battle against inflation, it is very clear as to who is doing its job of trying to bring it down. It is the RBI. The government has not done much and the central bank has left no stone unturned in pointing this fact out. The RBI governor Mr Subbarao has very emphatically stated that there is not much the central bank can do about inflation when the government is ruining the fiscal situation by overspending. Thus, while inflation has been easing of late, this may prove to be temporary and leaves very little headroom for the RBI to go in for rate cuts. Mr Subbarao maintains that upside risks to inflation persist from insufficient supply responses, exchange rate pass-through (caused by the rupee depreciating but imports staying high), suppressed inflation (subsidizing fuel prices at the retail level has played a role in keeping inflation down) and an expansionary fiscal stance (too much spending by the government). And what is more, each of these issues can be addressed only by the government.

So what does the government need to do? For starters, it needs to take a long hard look at the subsidy structure and find ways of bringing this down. Then, supply bottlenecks when it comes to distribution of food have to be done away with so that food inflation problems do not surface time and again. The idea is that the government needs to spend less on consumption and more on investment. But real solution is to push through reforms and not be mired in indecision of the kind that we are witnessing now. While these issues have been pointed out over and over again, the apathy of the government really makes one wonder whether any meaningful solution will be ultimately reached. Not everything can be done by the RBI.

Do you think that the RBI can do much in a scenario where the government is not doing its job of bringing its finances in order? Share your comments with us or post your views on our Facebook page / Google+ page.

And while we are on the topic of the RBI, the central bank has in its latest decision decided to inject liquidity into the system. In its third quarter review of monetary policy, the central bank cut the cash reserve ratio (CRR) by 0.5% bringing it to 5.5%. This move is expected to ease liquidity by injecting Rs 320 bn in the system. Policy rates on the other hand remained unchanged. But, there were also a few ominous warnings in the review. The RBI reiterated that sustained policy and administrative action is needed to stem the inflation problem. As mentioned earlier, the rocky fiscal position that India is in spells a threat to inflation. Concerns on high fuel prices, manufacturing inflation and rupee depreciation post upwards risks to prices. While the projection for headline inflation was left at 7%, India's GDP growth expectation was cut to 7% from 7.6% previously. Weak global growth and slower industrial production are to blame. Now, next on every investor's watch list has to be the latest Union Budget. We hope this will put forth the policy action India needs badly.

 Chart of the day
It is a well known fact that government debt has zoomed in the developed world so much so that most in Europe at least are struggling to keep head above water. But what is the scenario when it comes to household debt? Today's chart of the day shows that when it comes to household debt (as percentage of GDP), the developed world is still way ahead of the emerging economies. Indeed, if you look at India, despite the recent spike in household debt levels, it is still considerably lower than that in developed economies.

Data source: The Economist

A lot of institutions and people have been painted as villains of the epic 2008 financial crisis. None more so than the ratings agencies we believe. There is no question that these firms failed miserably in their efforts. But to be fair to them, the business models of ratings agencies also deserves a lot of flak as it incentivised bad behaviour. And correcting the wrong business model is the key if credibility of ratings agencies has to be restored. A giant step in this direction was taken recently when a German businessman announced the plan to launch an 'objective' credit ratings agency. The plans are at an advanced stage and a new firm could get down to the business of rating as early as the first half of this year. What is the real clincher is the fact that this new firm will have a business model where the service will be paid by the clients. Besides the idea of this ratings firm also accepting liability for its analysis is also being mooted. If such a firm does come into being, it will be the first real reform in the aftermath of the financial crisis we believe. Thus, firms with dubious balance sheets better repair their balance sheets lest their credit ratings come under the scanner.

While the European policy makers are busy chalking out various austerity plans to reduce wasteful expenditures in order to revive the economy, Noble economist Joseph Stiglitz is apprehensive about the effectiveness of such steps. He is of the opinion that while such austerity measures are commendable in this environment, they do not restore growth in an economy. True, that they improve the fiscal position of the government but are certainly ineffective to solve the current crisis. And right now the European Union needs a road map to solve the ongoing debt crisis which can instill growth and confidence back in the economy. We second his opinion here. Austerity is an action (corrective step) to a reaction (crisis) which is meaningless if not supported by growth. Perhaps, it's high time that the policy makers iron out their political differences and focus on restoring growth in their economies.

The global crisis that has gripped the world has led to the loss of many jobs. High unemployment rates are a source of worry for nearly every government. They are taking every possible step in the book to reverse the trend but so far no trick has really worked. The International Labour Organization (ILO) has recently released a report that says that the world economy needs to create at least 600 m new jobs in the next 10 years. If this does not happen, the world economy would see a serious deceleration of growth. ILO has urged global leaders to do everything possible to remove the uncertainty and fear in order to get the private investments back on track. This in the ILO's opinion is the only way to create jobs. If it fails to happen, the world would see a sharp increase in both unemployment as well as poverty levels.

When it comes to setting ambitious targets, trust the Indian government to go the extra mile in making fancy plans. However, all the enthusiasm fizzles out when it comes to the execution of the plans. Take the addition of capacities for the power sector for instance. The government had initially planned capacity addition of 78,700 MW for the 11th plan period. However only 42,000 MW is expected to come on stream by the end of March 2012. This is even after the Planning Commission scaled down the targets for 11th plan to 62,374 MW during mid-term appraisal. However, despite this appalling track record and huge backlog, the target for the 12th Plan Period (2012-17) remains optimistic. The Power Ministry has recently fixed power capacity addition target at around 1,00,000 megawatt for the 12th Plan period. The fact that during the 11th Plan period, the country has added about two-and-a-half times the capacity that was added during the 10th Plan period seems to be only condolence for the government. However, it hopes that strengthening research and development in power generation, transmission and distribution sectors will ensure better track record for the 12th Plan. We can only keep our fingers crossed.

In the meanwhile, the Indian stock market surged ahead on the back of the RBI's latest move to cut CRR and inject liquidity into the system. At the time of writing, the benchmark BSE Sensex was trading higher by 255 points (up 1.5%). Not surprisingly, banking stocks led the pack of gainers. As regards global markets, most Asian indices were trading in the green today and apart from India, gains were seen in China and Hong Kong.

 Today's Investing Mantra
"I don't want a lot of good investments; I want a few outstanding ones." - Philip Fisher

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4 Responses to "There is only so much that the RBI can do"

satheesh babu s

Jan 24, 2012

If the govt and other political parties have their "spending ways" for couple of years more, then we should be going the 1970s Argentina way a few years down the lane.



Jan 24, 2012

I don't understand and see any sanctity in the RBI monetary policy about tackling the inflation by strictly adhering to only one way of hiking SLR which has not shown any impact on control of inflation. The govt and RBI seem to be interested in more earnings through banks. How can inflation be checked if the taxes like VAT and other taxes and petroleum rates are abnormally increasing. When a farmer is not getting minimum support price for his produce, where's the question of triggering effect for inflation. it's all due to merchants's manipulations. Neither the govt nor RBI has been able to curb the inflation nor been able to cause the increase in growth nor been able to streamline the capital market and save it from the horrible volatility from the gravity of global economic factors. They have utterly failed to give hope to a small trader or investor and many have become victims of inefficient financial management and ineffective administration. Federal bank has almost reduced the int rate to zero and here RBI has increased many times and i wonder how RBI is content with its philosophy that it has done wonders in curbing the inflation. Don't they know that the black money and corruption are main culprits for the inflation and all the hassles. The govt and RBI has to change their mindset to give big impetus to the growth factor and thereby to stabilize the stock market.

- R K Chowdary


Piyush Singh

Jan 24, 2012

Very aptly said that
the government ought
to spend more on
investments and less
on consumption. Apart
from imprudent
spending, the channels
of government spending
is skeptical; it seems
that the government is
only entitled to earn
people's graces within
the ambit of the
upcoming elections,
and not for the
betterment of the
nation in a long-run.

The RBI sounds to be
maneuvered by the
government in curbing
of CRR rates; it seems
as if the government
has made a choice of
growth rate over
inflation issues.
Injection of more
liquidity, possibly ,
could give something
to the government to
brag upon (if it
reflects in the

The RBI is the apex
fiscal institution of
India, & it should
work with nothing but
autonomy - which, this
government, seems to
be mitigating.


Abhay Dixit

Jan 24, 2012

We are going Greece way. 5 years?

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