Your wait for lower interest rates is set to get longer

Nov 14, 2014

In this issue:
» Where India's inflation stands compared to its peers
» China investment growth tanks to 13 year low
» Moving from growth to inflation targets
» ...and more!

There are a couple of factors that determine whether your bank can lower your monthly interest outgo for funds borrowed. And prime amongst them is the rate at which the central bank, RBI, allows it to borrow funds from itself. Another important factor is the quantum of reserves that the banks need to keep aside for every rupee lent. Now, over the last three years, borrowers in India have had to see their monthly interest outgo move up at regular intervals.

The fact that price of almost every food and non food item moved to upwards justified the RBI's fight against 'inflation'. However, with the new government promising to keep prices low, expectations were anchored to interest rates heading downwards. When RBI governor Rajan's inflation target of 6% was breached, it was expected that rate cut would be announced any day. However, that did not happen! And in case you are waiting for the RBI to announce one in its December policy meet, let us assure you, that far from being the case.

The reason being - RBI is fighting a lone battle against inflation!

You see, banks globally have tried their best to keep borrowing rates at rock bottom. In fact the central bankers of the US, Europe and Japan have been playing musical chairs with one printing money after the other. The trillions that they have printed since 2008 have ensured that borrowing rates in these economies do not move up a single percentage point. However, what they have also done is disincentivise savers and stoke risk appetite. So institutional investors looking to fetch at least a reasonable return have been pumping money into India, given higher rates here. The result of which is that price levels in financial and consumer markets have refused to go lower.

The RBI, being the conservative central bank that it is, has had a tough time in explaining the problem to our own policy makers. And this time around it may have the challenge of convincing the whole country that lowering rates is not the best way forward. As opposed to the general perception, interest rates are not the reason for lower GDP growth in India. And a cut in rates will not automatically stoke growth.

The coming policy meet may therefore not offer any cheer to borrowers hoping for a lower interest burden and investors hoping for quick gains in stock markets.

Nevertheless, while on one hand, your wait for lower outgo on borrowed funds gets longer, on the other hand, we have something to be really thankful to the RBI for. That India is currently amongst the very few economies in the world, where bank deposits offer positive inflation adjusted returns.

Do you support the RBI's lone battle against inflation? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
Influenced by lower food and fuel prices, inflation in India has been on a descent recently. Consumer Price Index (CPI) for the month of October eased to 5.5%; an all time low since India started compiling CPI data in 2012. And with this decline, the clamour for RBI to cut interest rates has further increased. People from various quarters, from corporate India to the government of India, have been putting pressure on the RBI for a rate cut.

Thus we thought this would be a good time to step back and get a broader view on the subject of inflation. Today's chart of the day takes you through level of consumer price inflation in various developing as well as developed countries. Looking at it from this broader perspective, it does become evident that while inflation has been falling in India, it is still on the higher side compared to many other countries. So it may not be very surprising that we see RBI governor Raghuram Rajan dig in his heels as far as a steep rate cut is concerned.

Inflation still not that low in India

Since we just told you about why we think the RBI is fighting a lone battle, here is more on how the other central banks are thinking. If one reads the monetary policy statements of central banks in developed economies, there has been a major shift in their focus area. If you recall the depths of financial crisis of 2008-09, they called themselves nothing short of saviors of the world! Their money printing policies were supposed to stop the financial market collapse. Their efforts to bail out big banks were also in this direction. Come 2010, the next round of quantitative easing was meant to get global economy back on track. The idea of creating jobs with cheap money was then the US Fed's version of a pro growth monetary policy. However, none of the policies ever met the desired targets. It will suffice to say that none of these central banks were really able to use monetary policy tools to effectively solve the growth problem. So now they have begun to justify quantitative easing (QE) with inflation targets. The economy of Japan that has not seen any real growth for almost 3 decades is at the forefront. The European Central Banks that has failed to create jobs by printing money too has set an inflation target, in order to improve consumption.

Contrary to the other central banks, it is only the RBI that sees the 'problem' with artificial liquidity induced inflation. And it is in no mood to subject the Indian economy to such a systemic risk. Therefore even as it continues to get criticized for being too hawkish and anti-growth, what we know is that the RBI has the economy's best interests at heart.

One of the biggest movers and shakers of inflation, so to speak, has been China. That too for over a decade now. And a lot of this has been on the back of the huge investments the country has been making in creating fixed assets and other infrastructure. In the process also fueling the global commodity bull run that began in the early 2000s.

However, the winds of change have already started blowing. Recent macro data from China indicates that investment growth in first 10 months of CY14 has significantly slowed down, taking it to a near 13 year low! In fact, even recent factory output numbers seem to have missed expectations. Fixed asset investment in the 10 months to October grew just 15.9% YoY, the weakest pace since December 2001. Further, factory output grew 7.7% in October, the second lowest monthly reading since 2009 as per a Financial Times report.

With the appetite of one of the world's largest consumers of commodities declining significantly, it is no wonder then that commodity prices have been beaten blue and black.

China, on its part, is trying to shift from investment led growth to consumption led growth. But markets around the world, including commodity markets, remain fearful that weaker investment demand may lead to a sharper than anticipated slowdown in China's overall economy. Such an eventuality could also have in store grim possibilities like a spike in unemployment and acute stress in China's financial system. Something Chinese policy makers need to be wary about.But for now, many including India are simply busy cheering the collateral effect of a relief from the seemingly inexorable rise in commodity prices.

The Indian stock markets were trading strong today on the back of sustained buying activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 121 points, while the NSE-Nifty was up 40 points. Gains were largely seen in metal and realty stocks.

 Today's investing mantra
"Know what you own, and know why you own it.". - Peter Lynch

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7 Responses to "Your wait for lower interest rates is set to get longer"

Ramesh N Gole

Nov 16, 2014

Interest rate need not be cut at present till the time inflation is lowered from the current level to 4.2% of GDP.
This will indiacte that economy is on the way to show +ve signs of recovery and after having got surerity interst cut can be implemented from June 2015 onward.



Nov 15, 2014

RBI is right, few genuine low/middle income group borrowers of home,education etc will have some relief, majority depend on safe interest income on banks/post offices etc (middle class and elderly) they are always sufferers. prices of manufactured products, oil and other commodities prices do remain unaffected for common man, then why to listen to business lobby?change in rules is necessary for growth in manufacturing


Tikam Patni

Nov 15, 2014

In economic theory, higher interest rate reduces money supply and therefore reduces goods and services demand, which helps in keeping price rise under control. And when we have academicians dictating economic policies, they just follow this text book theory.

In India, the inflation is caused by 1)supply shortage, real or artificial, 2)accentuated by inefficiencies in supply chain and distribution mechanisms.

Reducing interest rates will help attacking both of these causes in a positive way to reduce real inflation.


vimalkumar jain

Nov 15, 2014



parimal shah

Nov 15, 2014

Two points.
1) The stock-screener is very good. Please tweak it that so as to be able to enter at least 9 matrices (search conditions).
2) If RBI targets inflation rate of 3 per cent the savings bank deposits will be encouraged and the money can be lent by banks for projects. With interest rates (in Saving bank) at 4%, the savings account will protect the value over time - encouraging people to save more and this will help growth cycle.


D D Kochar

Nov 14, 2014

I have given my views on interest rates once before also.I reiterate once again. All of us must have dabbled in politics sometime or the other.Till Modi govt gets majority in Rajya Sabha, there will not be any lowering of interest rates. This will be one of the major factor affecting the fiscal & economic policies of the govt.



Nov 14, 2014

Infation& Interest Rate...
For each Country we need to highlight the GAP between Inflation & corresponding Interest Rate. Then only we can make some sense out of Indian Interest Rate Cut.

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