CRR hike: Does 'he' care? - Views on News from Equitymaster

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CRR hike: Does 'he' care?

Apr 2, 2007

Mr. Chidambaram must be cursing Dr. Reddy for putting spoke in his 'India poised' wheel by raising the cost of 'growth capital' for one more time. By taking another step towards tweaking the money supply in the economy by raising the repo rate (which raised the cost of short-term borrowing from the Reserve Bank of India (RBI) for banks) as also the cash reserve ratio (that reduces the amount of funds available for lending in the economy), the RBI governor has once again indicated his seriousness with respect to inflation control.

RBI's parting shot!

If 'expert' words are to be believed, "stockmarkets are destined to open in the negative today" and "CRR news is bad for stock and bond markets and economy." Do you care? Do we care? Maybe! Maybe not! This decision by the RBI reflects the upside risks to price stability (inflation) over the medium term. Thus, the consequent hike in interest rates will contribute to ensuring that long-term inflation expectations remain anchored at levels consistent with price stability. Investors need to appreciate the fact that such an anchoring is a prerequisite for monetary policy to make an ongoing contribution towards supporting economic growth.

It is important to note that the 6% to 7% inflation in urban areas has not really tempered the demand for products and services. People are still buying cars, homes (some their second), 'beauty products' and (expensive) professional services. These comprise less than 20% of India's population (the urban rich and middle class). However, think about the 70% of India's population where inflation has soared to near 10% levels and it is becoming increasingly difficult (for the agriculture labour) to even make ends meet! Forget spending on potable water, 'free' electricity, basic healthcare and education.

Will this large proportion of the Indian population be bothered of whether the stockmarkets open in the negative (or positive today) of whether they would care if CRR turns out to be bad news for stock and bond markets? Take a guess! Their plates will still remain half empty! It is probably this dilemma of balancing growth across all sections of the economy that is keeping Dr. Reddy alert in his exploits on maintaining price stability.

Even Mr. Chidambaram will be alert, though for somewhat different reasons! His government has recently lost elections in two northern states, as the electorate has shown its wrath in response to rising prices of consumption items.

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