Are rate cuts the only solution to India's growth?

Jun 20, 2012

In this issue:
» Which foreigners are buying US homes
» Mobius believes that Europe will emerge stronger
» India, China join hands for oil assets
» Cement sector accused of cartelization
» ...and more!

--------------------------------- Get FREE: The Guide to Gold ---------------------------------

Will the gold prices keep rising in the future too?

Is it better to invest in gold or stocks? ...

'Gold Bug' Bill Bonner, answers these questions for you in the exclusive publication - The Guide to Gold

Quick! Sign up for our FREE newsletter, The Daily Reckoning and get this Guide FREE!


When India's GDP growth came in at quite a low figure of 5.3% for the March quarter, expectations ran high that the central bank would surely cut rates. The Reserve Bank of India (RBI), however, thought differently and chose to keep the rates unchanged. The signal was clear. As long as inflation remained high, rate cuts were not on its agenda. Thus, the onus was clearly on the government to overcome its lethargy and get India on the high growth path.

The central bank's decision has had its share of supporters and detractors. And this has raised the question whether cheap money was the answer to problems of slowing growth? We believe not. One need look no further than the US and Europe to gauge the impact of a loose monetary policy. Indeed, the developed world has kept interest rates close to zero in an attempt to kick start growth. And this has majorly backfired. With unemployment reigning high and consumption not really taking off, low interest rates have hardly provided the stimulus that those countries had envisaged.

There are other reasons too. One is that the key to growth are savings. If savers are at the receiving end with interest rates that are below inflation, they may be forced to chase risky assets in search of higher returns, thus putting their capital at risk. As mentioned earlier, since the RBI has decided to keep status quo, it is now upto the government to make tough decisions such as raising diesel prices and cutting wastage. Further, at a time when the rupee is falling, the only way to compensate savers abroad wanting to invest in India is by keeping rates high. As far as businesses are concerned, companies typically focus on the extent of returns generated. Thus, businesses may not have a problem with high interest rates as long as the returns are also good. The key here is to create a business environment conducive to growth and low interest rates may not necessarily be the only solution. Cheaper capital can impact job growth too. This is because companies may substitute capital for labour creating less employment for every rupee invested.

What all this eventually means is that the government will have to focus on growth through reforms, cutting down deficit and deregulation. Laying the blame on the RBI and making it the scapegoat for India's economic problems will not achieve much.

Do you think rate cuts are the only solution to propel India's growth going forward? Share with us or post your comments on our Facebook page / Google+ page.

 Chart of the day
The US housing market has been down in the dumps ever since the global financial crisis escalated in 2008. However, US homes have not lost their flavour for foreign buyers. As today's chart of the day shows, buyers in Canada and China accounted for a larger chunk of home sales to foreigners in FY12. For both the countries, this was a rise from homes sold in FY07. Both benefited from strong increases in the purchasing power of their currencies over this period. For those, whose currencies depreciated against the dollar, the scenario was the reverse as was the case with Britain. India's position remained unchanged despite the rupee depreciating significantly against the dollar.

Data Source: The Economist

That a company or a nation emerges from a crisis in much better shape than before is all too apparent. There is no reason why this should be any different for the Euro zone if at all it emerges intact from its present crisis. One man, Mark Mobius, believes that it certainly will. The guru of emerging markets is of the view that the Euro zone will require some big change. But the reforms will be undertaken and Europe will emerge much stronger than ever before as per him. Thus, investors who stay invested in safe havens for too long will miss the ensuing rebound in global markets, Mobius argued.

We beg to differ a bit. Mobius could perhaps do well to understand that the current crisis is unlike the world has ever seen before and hence, the same approach of investing for a rebound may not work. Certainly not before the debt problems in the developed regions are solved. Thus, investment in safe havens like gold is as much important from a return of capital point of view as the idea of investing in risk assets to earn the return on capital.

India and China have been in news together for row over oil exploration rights in South China Sea. However, thanks to high and volatile crude prices, the dispute is giving way to diplomacy. The two have now decided to join hands in their quest for oil and gas assets. The leading energy sector players in the two countries are planning to jointly bid for and explore oil and gas assets abroad.

However, too much of optimism on such development may be misplaced. This is not the first time that the two countries have decided to cooperate. Going by the past, a conflict of political and economic interests have over shadowed the steps taken to ensure energy security. That said, the decision makes sense as it will avoid aggressive bids and raising the value of energy assets abroad. Also, China is better off technologically in oil exploration. This can help India to make further inroads in deep water exploration and widen its geographical footprint.

Over the last couple of years, several Indian corporates have come under the scanner of the Competition Commission of India (CCI) and been consequently penalised. The list includes corporates such as DLF, National Stock Exchange (NSE), United Phosphorus. Even some explosives manufacturers and LPG cylinder makers have been fined. These companies had allegedly abused their dominant position in the industry, engaged in cartelisation and price manipulation. The next set of companies to be at the CCI's receiving end is major cement players. India's competition watchdog is likely to impose a fine of about Rs 30 bn on major cement firms. The order is likely to be announced in a couple of days.

A certain top official of CCI has said that the CCI had the power to impose a fine of 10% of the average 3 year turnover of the company. However, the penalty for cement players is likely to be in the range of 5-8% of the last 3 year's average turnover. The main reason for the likely lower fine is the overall weakness in the economy. Moreover, cement is an important input for key sectors.

Cement players have maintained that the cement prices reflect the increases in input costs. Also, cartelisation is always difficult to prove on account of a lack of solid evidence. The allegations of the CCI are mostly based on circumstantial evidence.

The Euro zone heaved a sigh of relief with the favourable outcome of the Greek elections. As the Euro disintegration was averted, the world too breathes easier. But the relief is short term. Troubles are still brewing in Spain and other parts of the zone. The Wall Street Journal recently tried to judge as to how Asia would be impacted by this crisis. It is true that all Asian markets would witness a decline if the crisis worsened but some economies are more vulnerable than the others. The list includes India, Vietnam and Japan. It is true that many other Asian countries rely more heavily on Europe to sustain their exports, which in turn form a large percentage of their exports. In addition to this, these countries also have a significant exposure to the European banks. But the the most vulnerable economies including India have their own domestic problems that would compound the impact of the Euro crisis. It is a well known fact that India is battling lower growth and higher inflation. To add to this it also has a huge mountain of government borrowing and a worsening fiscal deficit position. As a result, it would be unable to offer the kind of stimulus to its economy as it was able to back in 2008. Under such an event the impact of a full blown crisis in Europe would be of magnifying proportions.

In the meanwhile, the Indian equity markets traded in a range bound manner for most part of the day. At the time of writing, the BSE-Sensex was trading higher by about 55 points or 0.33%. Stocks from the capital goods and power sectors were amongst the favourites, while those from the IT spaces remained the top underperformers. Stock markets in other major Asian economies ended on a positive note with Japan and Hong Kong ending higher by about 1.1% and 0.5% respectively.

 Today's investing mantra
"Once we realize that imperfect understanding is the human condition there is no shame in being wrong, only in failing to correct our mistakes." - George Soros

Today's Premium Edition.

Recent Articles

All Good Things Come to an End... April 8, 2020
Why your favourite e-letter won't reach you every week day.
A Safe Stock to Lockdown Now April 2, 2020
The market crashc has made strong, established brands attractive. Here's a stock to make the most of this opportunity...
One Stock that is All Charged Up for the Post Coronavirus Rebound April 1, 2020
A stock with strong moat is currently trading near 5-year lows.
Sorry Warren Buffett, I'm Following This Man Instead of You in 2020 March 30, 2020
This man warned of an impending market correction while everyone else was celebrating the renewed optimism in early 2020...

Equitymaster requests your view! Post a comment on "Are rate cuts the only solution to India's growth?". Click here!

3 Responses to "Are rate cuts the only solution to India's growth?"

Ramesh B

Jun 21, 2012

your are right! It is proved that in the regime of high interest, Indian growth was not adversely affected!RBI has also mentioned is foul hue and cry to criticize in all seasons by the vested interests.Though paramount important is of course to reverse the state of inertia in Govt. decisions and corruption, black money,political mafias etc.



Jun 21, 2012

Not at all Inflation control must be first priority If low interest rate was panacea for growth why US is not growing at the rate of China India.In US Japan the short term interest rate is near 0 and still they are not able to grow more than at 2 while our growth above 6 Even when interest rates were quite high in 2003 2008 we could achieve higher growth around 9% which is clear indication that the interest rate is nothing to do with growth.The focus must be on containing inflation at below 3 so that cost of credit purchasing power of the consumer too will be very high Higher inflation will have greater effect on the stability of Rupee also
RBI by not focussing on inflation and buckling under pressure from both India Inc Finance Ministry is guilty of abdicating its constitutional responsibility of not protecting the interest of the depositor who is getting negative returns since 2009 and borrowers and particularly defaulters are getting concessions in the form of CDR loan write offs which is the tax payers money and could have resulted in lower budget deficit by increased profit of banks The easy credit to sectors which are not able to provide securities is also responsible for higher NPAs in banking sector
To reduce budget deficit,government must withdraw all the tax concessions extended to the private corporates which is around Rs 550000 crores.Subsidy for the deserving is the responsibility of the government and instead of cutting subsidy,government must raise taxes from those who can afford to pay higher taxes.Why a developing nation must have a lower tax rate than the developed country like US.UK France
Why we dont have social security system of respectable pension for all and universal free medical facilities to the aged
Why corporates are opposing CSR



Jun 20, 2012

Dear Sir,
Your views about RBI Rate cut are profound.I
agree on the point tree does not grow if roots
are not watered.Ball is in government's
court.Decision of RBI is well considered.

Equitymaster requests your view! Post a comment on "Are rate cuts the only solution to India's growth?". Click here!