»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:
» 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.

--- Advertisement ---
Free Book Offer

We have reserved a FREE copy of the book - "Seven Years to Seven Figures" (Worth Rs 872) especially for you!

To know full details on how you can claim this, please visit here.

 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

Copyright © Equitymaster Agora Research Private Limited. All rights reserved.

Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement

Disclosure & Disclaimer: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.

This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.

This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, Canada or the European Union countries, the same may be ignored.

This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.

As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

Equitymaster Agora Research Private Limited (Research Analyst) 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407