Are interest rate cuts around the corner?

Mar 27, 2012

In this issue:
» World GDP growth is on the decline
» Bull market for bonds is over
» Coal shortage to hamper power capacities
» Global grain prices to stay firm
» ...and more!

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When the Indian economy posted healthy growth rates in FY10 and FY11 post the global crisis in FY09, it was felt that the Indian growth story was very much on course. The slowdown of the economy in FY09 was very much a product of the global crisis. But given that Indian banks were well insulated and that India had a robust domestic demand to bank on there was no reason for the slowdown in that fiscal to spill over to the subsequent fiscals as well. Thus, the Indian economy was fortunate to see a strong recovery in both FY10 and FY11.

FY12 so far has been a different story altogether with very obvious signs of slowdown in the Indian growth engine. And this time around, the problems are well within and cannot be entirely attributed to the weak conditions in the developed world. For starters, although the Indian economy did well in FY10 and FY11, inflation reared its ugly head as food prices soared. And because inflation refused to cool off, the Reserve Bank of India (RBI) had no choice but to go in for 13 consecutive rate hikes. Thus, with interest rates rising and fuel prices remaining firm, the Indian economy began to slowdown towards the fag end of FY11. This has continued in FY12 as well. Moreover, the government's inability to bring its finances in orders has only added fuel to the fire.

In such a scenario, all eyes have been on the RBI to prop up growth in the Indian economy by reducing rates. So far, the central bank has obliged with cuts in the cash reserve ratio (CRR). But whether it will cut rates at the same pace as it hiked them is a debatable point. The key here is inflation. And there is a possibility of that staying firm in the coming months.

For starters, the Union Budget has hiked basic excise duty by 2%. If passed on to consumers (and they most likely will be), they will raise prices throughout the economy. A railway freight hike, announced just before the Union Budget, is also expected to play its part in lifting inflation. Then there is the issue of rupee depreciating against the dollar once again leading to 'imported inflation'. Further, wages under the government's flagship rural employment guarantee scheme have been hiked. This is likely to lead to higher farm labour costs and ultimately, higher produce prices. State governments are also jumping the bandwagon by hiking prices on an array of goods as they struggle to make up revenue deficits. And to top it all, with oil prices staying firm, another hike in petrol prices could just be around the corner. In such a scenario, the possibility of the central bank going in for successive rate cuts seems quite dim indeed.

Do you think the RBI will go in for cuts in interest rates in the subsequent quarters? Share comments with us or you can also comment on Facebook page / Google+ page.

 Chart of the day
After being down in the dumps in 2009 on account of the global financial crisis, world GDP growth picked up at the start of 2010 as the emerging economies posted a strong revovery. But from there everything has gone downhill once again. As today's chart of the day shows, world GDP growth has steadily declined in the subsequent quarters after reaching its peak in Q2, 2010. The reasons are not hard to find. The developed world especially Europe have been racked with massive debt and possible defaults and emerging economies notably China and Indian have also slowed down.

Data Source: The Economist

In a previous issue, we discussed Bill Gross' statement about the end of 30 year bull market in bonds. Now Blackrock, another wealth management firm of global repute, has jumped into the fray. Like Bill Gross, a top executive at Blackrock also believes that the bull market for bonds is well and truly over. So far, so good we believe. But the gentleman didn't quite go down well with us on one point. The point being his assertion that shrinking supply, high demand and ultra-loose monetary policy will conspire to keep a tight lid on yields. We have a slightly different take on this. When it is clearly known that yields will spike up some time in the future, why take a chance with one's investments. Government bonds are good for big institutions and pension funds for whom the return of capital matter as much as the return on capital. But the same will turn out to be a bad investment for people looking to earn decent double digit returns over the long term and who are willing to take some risks.

Coal is a principal source to generate power in India. And right now, India is experiencing significant coal shortages. As a result, the power generation plans of the country have taken a backseat. As per news reports, roughly 46,000 MW of the planned power capacity is at stake due to coal shortages. Importing coal is an option available to state/private utilities to meet the current supply shortfall. However, higher price of imported coal and regulation of the end user tariffs make imports unfeasible.

Unable to get timely fuel linkages has also deteriorated the financial health of the power producers. As a result, the government directed Coal India to sign fuel supply agreements with them. But this has effectively subsidized the private power producers as Coal India is mandated to sell at a certain fixed price. It is not a long term solution to the current supply issues. We believe that in order to come out of the current mess, government has to de-regulate tariffs. This would mean coal imports become feasible as prices can now be passed on to the customers.

The unemployment rate in the United States has moved sharply lower from 9.1% to 8.3%. However, Fed Chairman, Ben Bernanke believes that this decrease was 'out of sync' with the country's modest pace of economic growth. For the whole of last year, the GDP grew by only 1.7%. While it grew by 3% in the fourth quarter, growth is expected to shrink to 2% for 1QCY12. For a sustained reduction in the unemployment rate, a rapid expansion in production and consumption is needed. Since December 2008, the US central bank bought US$ 2.3 trillion in debt securities in order to spur growth. However, while still keeping rates at near zero levels; the Fed has not yet indicated whether it will purchase more bonds. Bernanke seems to be in the middle. Biding his time till he believes an additional infusion is really necessary for the economy to grow faster.

Inflation was one of the main concerns of emerging economies in 2011 and was primarily driven by high food prices across the globe. This led to tightening of monetary policy and slowdown in many countries. Although the food prices have come down in the first two months of 2012, the trend is not expected to continue for long. According to the United Nations Food Agency, prices of grains and vegetables will remain firm due to demand - supply mismatch.

Demand, especially from Asia is expected to remain strong while supply is going to be less than previous estimations due to the drought in many South American countries. This will lead to increase in food prices. The UN food agency has also warned that the food prices may become volatile as unpredictability in prices is increasing. As a result, high food prices are moving to the top of policymaker agendas, driven by fears it could stoke inflation, protectionism, civil unrest and dent consumer demand around the world.

The Indian stock markets shed initial gains and were trading marginally above the dotted line. At the time of writing, the BSE Sensex was up by 49 points (0.3%). Among sectoral indices, consumer durables in particular were doing very well, trading higher by 1.4%. Power stocks that were down by 0.7% led the list of losers. China was the only loser in Asian stock markets.

 Today's investment mantra
"The best stock to buy may be the one you already own." - Peter Lynch

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5 Responses to "Are interest rate cuts around the corner?"


Mar 29, 2012

Time is not appropriate for any review and reduction of repo/reverse repo rates by the monetary Authotity.Inflation is not fully reflected as fuel prices are not fully passed on to the consumers.Threat of crude price hike due to Iran stand-off looms large.
Any easing in the policy could be by a calibrated manner without causing liquidity gush.Steps already initiated by RBI are praiseworthy.


g r chari

Mar 27, 2012

With the govt. giving a push to cost-push inflation post the hike in excise duties in the budget and short-term bond yields remaining high, it may not be prudent for RBI to reduce the interest rate as yet. Even the RBI's move to reduce the CRR, to add more liquidity in the system is only going to stoke inflationary pressures in the economy. Given the present state of the Indian economy, we should be prepared for a stag-flation type of situation.



Mar 27, 2012

Rate cuts? Not likely in April as April first week will be the Petrol/Diesel price hike.


P Sai Babu

Mar 27, 2012

Recently Duvvuri Subba Rao, RBI Governor gave a lecture on Macro economic issues at Vijayawada which the self had attended and in that he explained in brief the role played by RBI in controlling Inflation by hiking Repo rates which in turn led to increase in Deposit rates.

He also mentioned that many industrialists had approached him on the adverse effect the high interest rates are playing on the cost of production and when he countered them on the overall impact in cost of production as a result of high interest rates they could not come with a tangible reply and then he continued his lecture saying that the net impact on the ultimate cost is minuscule.

How RBI alone can control the inflationary trends when Central government is hiking Fuel prices citing the world crude oil prices, Fertilizer prices,Rail freight charges and ultimately the invisible and erratic behavior of Environment that causes havoc to the farm production.

Hence taking all the above into account, there is a hidden inflation in the system that gets exploded in the coming months and hence RBI may wait for some more time to decide on interest rate cuts.


ramachandra bhat

Mar 27, 2012

We may have to wait for some more time before the reduction.
Before the reduction the RBI may watch the inflation since the policy decisions can not be reversed inorder to please some body/economy. Even, it is not in the interest of a country.

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