|»5 Minute Wrap Up by Equitymaster|
On This Day - 2 APRIL 2014
Why RBI will continue to remain a hawk...
In this issue:
A hawkish stance means that RBI will not lower interest rates in the near to medium term unless inflation settles down within its comfort zone. While the Consumer Price Index (CPI) inflation may have declined to 8.1% for the month of February from 11.8% a year ago, core inflation has hovered around 8%. And this indicates that inflationary trends in the economy have failed to subside. Core inflation excludes the impact of food and fuel inflation, which happen to be most volatile. Thus, it is an indicator of underlying long term inflation.
Apart from core inflation, even food inflation which has subsided for the time being, is likely to rear its ugly head again. The fears of El-Nino are getting stronger by the day. Concerns over scanty rainfall have also emanated recently. This is likely to raise food prices. Higher farm gate prices are not helping either.
When it comes to fuel inflation, the situation is slightly better. Appreciating rupee has made imports cheaper. As a result, petrol prices were cut recently while the decision to hike diesel prices was postponed. However, international crude prices being highly volatile and India being a net importer of crude, threat of rising fuel inflation can never be overcome completely.
Further, if the new government clears the decision on gas price hike, it shall pose further upside risk to inflation. A gradual reduction in complex fertilizer subsidies, in fact any subsidy for that matter, is also a threat to inflation. Take the case of reduction in fertilizer subsidy on inflation. As subsides reduce, fertilizer companies increase the end product price, which burdens the farmer and ultimately the end consumer in the form of higher food inflation. As India is slowly moving out of the subsidy era, inflationary threats continue to remain.
Higher inflationary environment in general means interest rates are likely to remain high. Thus, RBI is likely to remain more hawkish than dovish in the near to medium term.
What does this mean for the economy?
Higher interest rates deter capex cycle. They slow down investments and hurt growth. And with RBI having prioritized inflation over growth, interest rates may remain high. Thus, growth may continue to take a backseat.
However, it should be noted that interest rate is just one of the factors that impacts investment cycle. Other factors like better policy making and reduced bureaucracy also matter. And it is the government which is responsible for managing them. If the government improves policy making and ease of doing business, then the interest rate hindrance can be easily overcome. This shall kick start the growth cycle.
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He has argued that the US stock market now faces a near routine rigging. The modus operandi is awfully simple. Here, there are elite traders that have access to high speed network. And this network figures out what other small investors have just ordered, order it first and then raise the price just before the order of the small investors is complete. In other words, front run a trade and that too in a totally legal way. Of course the pay off from such an approach is not very high. But spread it over hundreds of thousands of transactions and we could well be talking millions and billions of dollars worth of gains we believe. Clearly, looks like man's greed knows no bounds.
Moreover, even though debt has bloated, the repercussions may not be as severe as in the West simply because those markets are saturated whereas the dragon nation still has potential to grow. Having said that, credit cannot grow indefinitely in China unless it is also followed by growth. The latter in the last couple of years has slowed down. Thus, it is only a matter of time before the pace of credit expansion also falters. Thus, the only long term solution to China's ills would be the emphasis on reforms.
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