Will Raghuram Rajan lower interest rates? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Will Raghuram Rajan lower interest rates? 

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In this issue:
»  Real estate inventory in cities quite high
» Is another Asian crisis on the way?
» Big banks allowed to get away with only fines
» Gold imports may surge in coming months
» ...and more!

When Dr Raghuram Rajan donned the mantle of the new RBI governor recently, markets gave him the thumbs up. Certainly his maiden speech had the impact of causing the rupee to pare some of its losses and climb higher. A lot of hope is now pinned on him. There are expectations that he will finally be able to implement measures that will provide the much needed boost to an already beleaguered Indian economy.

But this is easier said than done. One of the key concerns that the former governor Mr Subbarao had to deal with was persistently higher inflation. Because of his refusal to lower interest rates to kick start growth, the RBI was constantly at loggerheads with the Finance Minister. Mr Rajan is set to face the same issues. For inflation continues to remain a problem. Indeed, wholesale price inflation (WPI) has climbed to 6.1% in July 2013. Although the rupee has gained in recent weeks it is still weak compared to the scenario last year. And uncertainty in the global markets means that fluctuations in its movement cannot be entirely ruled out. This puts the new governor in a quandary and signals that the much expected rate cut may not actually happen.

If that happens, the ball will once again be in the government's court. What is worrying is that inflation has stayed high even when both GDP growth and consumption demand have considerably slowed down. This means that supply side shocks continue to exist and the government has done little to address them. The hoarding of onions and the hike in prices in recent times is a classic case in point.

What is more, it seems all the more likely that the current government will not really pull up its socks to resolve these issues given that elections are just around the corner. Till then it will be the RBI battling to restore confidence in the economy. And it will be interesting to see how Mr Rajan chooses to handle the Finance Minster. But from a longer term perspective, the government cannot continue its state of apathy. Unless measures are put in place to ensure that there are no supply bottlenecks, inflation will continue to rear its ugly head. And the RBI will not be able to come to the rescue all the time.

Do you think that the recent rise in wholesale inflation means that the RBI will not cut rates? comments or post them on our Facebook page / Google+ page

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01:26  Chart of the day
The rise in WPI has just made the job for the RBI tougher as the new RBI governor comes up with his policy later this week. But there was some breather on the consumer inflation front for India in July 2013 as this was slightly lower than what it was during the same month last year. But when compared to other countries, consumer price inflation is still way ahead and continues to remain a problem. Indeed, countries such as China, the US and Japan have reported inflation lower than 3%. However, it is interesting to note that when compared to the same month last year, all the 3 countries have seen inflation climb higher.
Consumer inflation in India remains high
*Data for China and Eurozone is for Aug 2013
Data Source: The Economist

The inventory figures in the real estate market are a key to understanding where the market is heading as a whole. A higher inventory figure means sales are not taking place. And declining sales means there is no demand which is predominantly due to higher prices. Thus, higher inventory levels are a sign that price correction is likely. Now, let us see what the inventory position of key cities in India is. Please note that inventory position is stated in months. So, when it is stated that inventory position in Mumbai is 30 months it effectively means that it will take builders approximately 30 months to sell off the entire inventory in the market. Thus, higher the inventory in months, lower is the sales volume. This signals poor market volumes and illiquidity in markets.

As per news reports, inventory levels in Mumbai stand at 48 months. In Delhi, the figure is 23 months. These figures are at an all time high. This signals that prices are unaffordable. With prices being so high the only way where they can head now is downwards. While it is difficult to tell when the correction will happen, we feel it will be sooner than later.

In the wake of the global crisis, the Asian economies had come in the limelight due to their stellar growths. Investors from all over the world were flocking to these economies as their asset classes offered much higher returns as compared to their developed counterparts. But things seem to have taken a turn for the worse. These economies are now slowing down. Most of them are burdened with gaping deficits that are being funded with debt. Since the US Fed announced the likelihood of tapering off its QE program, the Asian currencies too have come under pressure. The resulting times are erringly similar to the Asian crisis of 1997. Therefore one may wonder if another Asian crisis is on its way.

Paul Gruenwald of Standard & Poor's thinks that this is not the case. He feels that things are much better than what they were back in 1997. For most of the Asian countries the external balances are much better. They either have narrow current account numbers or have sufficient forex reserves to cover it. The most vulnerable economies this time are India and Indonesia. But in these economies the debt levels have not risen very significantly. And for economies that have seen debt levels soar, they have sufficient forex reserves to tide them through.

For India and Indonesia in particular, the woes are more or less due to political reasons. Things are expected to improve post the general elections that are scheduled to take place next year. Following that, everyone hopes that the much needed reforms will start to take shape. Once that happens, the investment cycle will take a turn for the better which in turn will drive the economic growth. As such, a lot depends on the reforms. If they come through, then the pain being felt will be temporary. But if they don't, then all likelihood we would be looking at an economic crisis. Unfortunately for us, India would be playing a big role in it, for all the wrong reasons.

One of the biggest reasons for the global financial crisis to unravel in 2008 was the risky practices adopted by big banks. Most of them were deemed too big to fail. And when they were indeed on the verge of failing, the government stepped in to bail them out. It naturally followed that measures were needed to put in place to reduce the size of banks in order to make them more manageable. And impose stricter regulations with respect to how these banks were run? But five years down the line, not much seems to have changed. Take the case of JP Morgan. The bank has stated that its legal losses could reach US$ 6.8 bn. That is a huge amount and shareholders should have been worried. But the stock gained around 35% instead. One of the reasons could be that US$ 6.8 bn is nothing much compared to US$ 23 bn that the bank is expected to make this year. That is the problem. In order to ensure that shareholders do not lose money, most of these banks are allowed to get away with shady practices with the payment of only fines. Why make shareholders lose money by imposing stricter penalties? But in the longer term, shareholders would actually stand to lose. Banks will accept that risky practices will come at the cost of some paltry fine. In other words, it contributes to market dysfunction by allowing companies to treat litigation as just a cost of doing business. This cannot obviously be the case. Which is why regulators and prosecutors will have to adopt a stricter stance and strengthen rules with respect to fraud and conspiracy.

India's trade deficit numbers showed a dramatic improvement month on month in August 2013. Naturally the slowdown in gold import was the reason behind the same. However, it was not just the price of gold that influenced this trend. What also influenced it was the confusion over government regulations. Most gold importers chose to defer their purchases due to the confusion over share of imports to be re-exported. In fact as per an article in Firstpost, with the confusion getting sorted out, gold imports may surge in the coming months. The festive season may also add to momentum. This could not only yield pressure on the trade deficit but also pressurize the rupee once again. As we said before, both the change in economic fundamentals and trend in rupee are temporary. And investors should overlook such trends.

So, should you buy gold now? And if yes, how much? We know it is questions like these that concern you these days. And your trusted source for views and opinions, The 5 Minute WrapUp, too has unfortunately not helped by staying silent on such questions. We understand that, in addition to stocks, you might be concerned about other asset classes like fixed deposits, gold and property as well. And that's why we are taking steps to make The 5 Minute WrapUp more relevant to you. Watch this space for more details in the coming weeks!

The Indian markets hovered around the dotted line throughout the morning session. At the time of writing, the BSE-Sensex was trading flat, down by a few points. Stocks were trading mixed with those from the information technology, metals and auto spaces leading the pack of gainers. Power and engineering stocks were amongst the top losers. Midcaps and smallcaps were trading weak with the BSE Mid Cap and BSE Small Cap indices down by about 0.5% and 0.2% respectively. Stock markets in other parts of Asia were trading weak with Japan, China and Hong Kong down by 0.7%, 2% and 0.3% respectively.

04:56  Today's investing mantra
"One of the biggest mistakes is to focus on a stock price instead of its value."- Warren Buffett
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5 Responses to "Will Raghuram Rajan lower interest rates?"

monish gaur

Sep 19, 2013

Its not like there being any compulsion to tinker with existing rates, but the fact is economy deserves a new kick start, a new boost and the reason to hold the RBI review after Fed decision to prolong tapering only gives the Guv little window, so I bet we r gonna c a .25 or a more meaningful .5 rate cut and after tapering a throwback, cheero.....take this as gospel truth from me, an ex IMIte.



Sep 19, 2013

After FED this is the right time to cut the rates, it will be a life saving drug for economy



Sep 18, 2013

Rajan will certainly look at a rate cut



Sep 18, 2013




Sep 17, 2013

if inflation is due to agricultral items, it is time to lower the rates as can expect good crops due to good monsoon.

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