This is why the RBI is not keen on further rate cuts - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
PRINTER FRIENDLY | ARCHIVES

This is why the RBI is not keen on further rate cuts 

A  A  A
In this issue:
» Why is gold still a good buy?
» Investment advice from Buffett
» Are Germans really poorer than other Eurozone countries?
» The bubble in Chinese credit card industry
» ...and more!


00:00
 
The virtues of cheap credit. Probably Alan Greenspan, Ben Bernanke and Timothy Geithner should have written a book on this way back in 2009. Interestingly, since then, the fondness for cheap credit has only grown. Not just the Americans but Europeans and some Asians too have bought into the logic! In fact ECB chief Mario Draghi and Japanese premier Shinzo Abe too have joined the cheap credit supporters club. But trust RBI chief Subbarao to take the road less tread.

The cut in repo rate yesterday was not the least attempt by Reserve Bank of India (RBI) to agree with its peers in the West and Japan. In fact the governor made it amply clear that key macro-economic numbers will have to show substantial improvement before any further cut. He particularly hinted at current account deficit (CAD) and consumer inflation.

Governor Subbarao has very valid reasons to dismiss the virtues of cheap credit. The US and Europe hailed cheap credit as the harbinger of GDP growth and employment opportunities. The reality was far from this. Nearly three years after interest rates were brought to near zero levels, none of the economies are seeing any signs of economic or job recovery. For India too, the rate cut history, though short, is not very enthusing. Cumulatively, the central bank reduced repo rate by 1% and the cash reserve ratio (CRR) by 0.75% during the fiscal. But this has had no impact whatsoever in stimulating credit growth. On the contrary, bank credit growth (14% YoY) in FY13 was nearly at a decade low. The government's hope that a generous stance from the RBI will help ease inflation pressures also fell flat.

Stock markets are known to draw temporary relief from instances like interest rate cut. The premise is that corporate earnings will get a boost from lower cost of leverage. But banks are unwilling to pass on lower rates, particularly to risky sectors. Companies are unwilling to borrow more despite cheaper credit. Hence the market's optimism is also short sighted.

We believe that the RBI, as always, is doing the right thing by adopting a prudent approach to rate cuts. Also, neither should the government pressurize the RBI to cut rates beyond its comfort zone. Nor should investors take cues about improvement in corporate profitability based on trend in interest rates. Companies in India might have to live with relatively higher interest rates until overall macroeconomic scenario improves. Companies with unreasonably high leverage ratios therefore cannot be a safe investment bet. Those who do not have high debt on their books are anyways not affected by movement in interest rates.

Do you think the RBI's reluctance to cut interest rates further is justified? Please share your comments or post them on our Facebook page / Google+ page

---------------------- An investing approach your stockbroker may not want you to know... ----------------------

Most stockbrokers just keep recommending one stock after another saying it's hot or giving some other vague reason.

And most investors, since they don't know any better, keep buying whatever their stockbroker tells them to.

But if you want to build REAL life-changing wealth from stocks, that is not the right way to go.

It all comes down to this investing pyramid, and whether all your stock acquisitions constantly meet the criteria set by it.

Yes! To find out full details about this pyramid, Click here...

But please note that this opportunity will be available for a short time only.

-----------------------------------------------------------------------------------------------------------------------------

01:35  Chart of the day
 
If you thought the RBI's only concern currently is poor credit growth that is not entirely true. In fact the quality of credit in the current system is much more of a worry. At the end of March 2013, the total value of restructured loans in Indian banking system crossed Rs 2.2 trillion! Restructured loans are not just the fallout of indiscriminate lending to priority sector, particularly agriculture. In fact most big ticket restructured loans are cases of genuinely poor credit quality assessment by the lenders. That is the reason not just public sector but several private sector lenders too have shown deterioration in credit quality. Thus while the banking sector is struggling to come to terms with historically high proportion of bad loans, the RBI does not want them to get aggressively lenient on credit costs.

Data Source: RBI


02:05
 
Globally the price of gold has corrected. But the correction has been more on the price of paper gold. It has not been very prominent in the physical market. In fact the physical gold is still trading at a high price. What is the reason for this? As per Casey Research, the demand for physical gold is currently at an all time high. The source of demand is from the wholesale side, i.e., from bullion banks, bullion traders and gold refiners. At the same time, the supply has been kept very tight. This is true not just in the wholesale market but also in the retail market. So the net result is that there is a market where demand is high but supply is restricted. What would happen to the prices? Well they would go up. And when prices of the physical gold go up, eventually the price of paper gold will follow. Therefore investors would do well to hold gold in their portfolios. In our opinion investors should be invest at least 5% of their portfolios in gold.

02:35
 
Woodstock of Capitalism'. Yes, that's what the AGM of Berkshire Hathaway, the investment arm of the most successful investor the world has ever known, has come to be known as over the years. This year too, thousands will descend into Omaha. Packing themselves into auditoriums, they will try and latch onto every word of advice dispensed by Warrren Buffett and his partner Charlie Munger. Well, what's the biggest or most important of them all? It is that stocks shouldn't be bought for a day or a month in the hope that one sells it to someone for a higher price. It should be viewed as just another productive asset. In other words, one should try and assess the kind of income that one will get from it. And then decide an appropriate price to pay for it. Cling on this one piece of advice from the investing legend and you may never have to rely on anything else we believe.

03:03
 
Who is the poorest in the Eurozone? A recent study released by the European Central Bank (ECB) suggests Germany. And it goes without saying that this has created a huge political uproar in Germany. Why, after all, should a poor country be paying for the sins of other rich Eurozone countries? As per the study, the median German household wealth is the lowest among Eurozone countries. On the other hand, troubled countries such as Spain and Italy seem to be three to four times wealthier than Germany.

What does this mean? Is Germany really poor? If you take this study at face value, you couldn't be further from the truth. So what could be the reasons for Germany's poor statistics? Firstly, Germany seems to have the highest level of income inequality among Eurozone countries. As per an article in Social Europe Journal, the top 20% Germans have 149 times more wealth than the bottom 20%. This explains why the median household wealth appears to be relatively lower than others.

Secondly, household wealth only partially reflects the economic status of the country. A large share of wealth could be with the government and corporates. So if you put together domestic capital stock and net international investment position, you see Germany at number three among Eurozone countries. Whether Germans should be paying for the troubles of other Eurozone nations is a different matter. But this episode indicates that statistics is a tool that must be used with utmost diligence.

03:22
 
Freebies are an effective way to entice. Especially when the product that is being sold along with it has no differentiation in value. In that case, the extent of freebies doled out becomes the central point of purchase. Such is the case with Chinese credit card industry right now. It would not be wrong to say that most companies are in a virtual battle to grab credit card customers. And in order to do that they are offering various freebies ranging from waiver of subscription fee to various types of discounts on product purchases. With interest rates on the credit card fixed at 18% the only differentiating factor is the extent of added benefits that one can get from subscribing to the credit card. Thus, customers pick and choose the ones where they are benefited the most.

It may be noted that because of rising delinquency, the credit card business is no longer that profitable. Yet there are many banks that are dying to get subscribers on board. Why? The reason being that once a customer comes on board, they can then cross-sell other banking products to them. Also, the general belief is that as more people start rolling over their debt the business would become more profitable. Thus, banks are trying to play on an expected future trend.

However, this aggressive marketing strategy can backfire too. In their bid to expand, if subprime borrowers get a hand over credit cards, defaults may rise. This can jeopardise the banking system. Also, if rollover of debt does not happen banks get to earn little by the way of interest. While the Chinese banking regulators might be aware about these risks they also need to ensure that there are proper checks and balances in place.

04:00
 
All the major global indices, barring the Japanese index, continued to have a positive outing over the week. A strong US jobs report by the Labor Department saw the unemployment rate being revised downwards to 7.5%, the lowest in four years. This helped allay fears of slowdown in the world's largest economy and bolstered the US markets which were up by 1.8%.

Positive cues from the US jobs data had a rub-off effect and helped in overcoming uncertainty following downgrade of economic forecasts by the European Union. The European Union had earlier said that it expected the 17-country Eurozone economy to shrink by 0.4% this year. This is 0.1% higher than its February prediction. The stock markets in Germany and France posted the sharpest gains of 3.9% and 2.7%, respectively. The UK market was up by 1.5%.

The Indian markets closed the week on a positive note with the shares in the FMCG space leading the gains. The Indian stock markets were up by 1.5%. The Brazilian index surged by 2.3% backed by rally in the stock of largest airplane manufacturer Embraer. Even the Chinese market was up by 1.3% over the week. The Japanese market was the only loser as strengthening yen dimmed hopes of boosting corporate profits.

Data source: Yahoo Finance, Kitco


04:50  Weekend investing mantra
"When stocks are attractive, you buy them. Sure, they can go lower. I've bought stocks at $12 that went to $2, but then they later went to $30. You just don't know when you can find the bottom." - Peter Lynch
The 5 Minute WrapUp Premium is now Live!
A brand new initiative of Equitymaster, this is the Premium version of our daily e-newsletter The 5 Minute WrapUp.

Join us in this journey to uncover the sensible way of managing money and identifying investment opportunities across various asset classes including Stocks, Gold, Fixed Deposits... that over time can help you realize your life's goals...

Latest EditionGet Access
Recent Articles:
How Unique Are the Companies You Invest In?
August 21, 2017
One of the hallmarks of successful investing is to look out for companies that have a unique and enduring moat.
You've Heard of Timeless Books... Ever Heard of Timeless Stocks?
August 19, 2017
Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.
Why NOW Is the WORST Time for Index Investing
August 18, 2017
Buying the index now will hardly help make money in stocks even in ten years.
This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process)
August 17, 2017
A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.

Equitymaster requests your view! Post a comment on "This is why the RBI is not keen on further rate cuts". Click here!

8 Responses to "This is why the RBI is not keen on further rate cuts"

BASKARAN

May 6, 2013

The RBI Governor is bothered about inflation based on increase in price of Potatoes and tomatoes in local market, hence he is worried about further rate cut.He is not bothered about the stagnation in manufacturing, banking and real estate sectors which will improve the nation economy.
Mr. Subba Rao is listening to wifes advice rather than Finance minister Mr. Chidambarams advice. If he goes against wifes decition he will not get food at home.

Like 

Rajkishore Karoor

May 5, 2013

Low interest rates act as an aid to hoarding and price increases. Experience shows that demand for products and services can only be created by increasing purchasing power or disposable income in the hands of buyers. Reduction in interest rats may decrease borrowing costs of buyers who use loans for purchases but in reality increases the overall cost of purchase to a buyer. Leveraged purchases, often justified by or marketed to buyers set off inflationary pressures on prices of goods and services resulting in an erosion in savings and value of domestic currency and can often create a viciously unstable currency leading to loss of confidence in the currency/economy.

Like 

Srinivasan

May 5, 2013

This's nothing new given the fundamentally sound RBI governors we have had in the recent past.
With 4 months to go for the current RBI governor's term... The government must just be waiting for getting in an appropriate next RBI Governor.
Hopefully, if recent history is anything to go by - once a person becomes RBI governor, they will maintain the long term national perspective - just as our past 2 RBI governors have shown...

Like 

Sarat Chandra Madala

May 5, 2013

What is the point of cutting the interest Rate? We all should know ow that interest rate is nothign but cost of money, so as the cost is lowered, the loans taken will increase and hence more pjysical activity shall take place. But this is nly partially true, as economic activity shall pick up only when a host of otger governance institutions shall function properly. The dispute redressal mechanisms, policy making bodies, clarity by regulators, etc are all an important part of the eco system and currently it is not RBI but our executive and legislature that are to blame for this impasse

Like 

B S MURTHY

May 5, 2013

If we want a stable economy, we want to have stable interest rate structure. Stable interest rates would enable government planners, corporate planners to have their stable business plans. To have successful Five Year Plans, we should have interest rates fixed, tax rates fixed, salary structures fixed, wage structures fixed, consumer prices fixed all in advance for the entire plan period. Then only we can achieve targeted growth. Dduring this period, Politicians should not play any vote catching gimmicks.

Like 

AJ

May 5, 2013

These are just the cheap gimmicks of the industry leaders in order to improve upon their bottom line and nothing more. With the current political scenario and the mood no new major infra projects are around which will generate new employment opportunities and increase the purchasing power of the common public for the economy to show some vibrancy. At least let some savings figure go up. As such housing sector with its glut are now making the realtors to realize their greed. Hats of to our central bank for its strong views on the economy and not falling in line with the deceptive west which are more than interested in bringing down the global economy along with them. Wicked attitude of theirs.

Like 

V V S Prasad

May 4, 2013

A very good analysis and more realistic one.

Like 

Narendra Kotecha

May 4, 2013

Unless we have a proper social security system for old retirees as they have in US & Europe, it is folly to talk of reducing interest rate.

What happens to millions of private sector retirees who have no DA linked pension like government servants and live only on interest on their savings ?

Specially those who have no children and are now getting old and infirm ?

Like 
  
Equitymaster requests your view! Post a comment on "This is why the RBI is not keen on further rate cuts". Click here!

MOST POPULAR | ARCHIVES | TELL YOUR FRIENDS ABOUT THE 5 MINUTE WRAPUP | WRITE TO US

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 (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, 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. 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