|»5 Minute Wrap Up by Equitymaster|
On This Day - 14 NOVEMBER 2014
Your wait for lower interest rates is set to get longer
In this issue:
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.
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.
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.
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.
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