Is the RBI Stoking Inflation? - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Is the RBI Stoking Inflation?

May 26, 2016

The actions of the Indian central bank to tame inflation and manage exchange rates have been commendable. We have a blunt governor who is not afraid to speak his mind. Even better, he believes controlling inflation is a greater concern than chasing growth.

In his fight against inflation, the governor has come out strongly against the government's fiscal imprudence. And he has asked the government to urgently address supply-side concerns, as they are a key reason for sticky inflation.

Hmm...

But the central bank seems to be doing its own version of quantitative easing (i.e. printing a lot of money). Over the past five years, the RBI has expanded its balance sheet at a rate of 13% compounded annually, from Rs 17 trillion in 2010-11 to Rs 32 trillion in 2015-16.

Consider this: India's nominal GDP growth rate during that period was 12% compounded annually. Nominal GDP indicates real GDP growth plus inflation. Printing money at a faster clip than the nominal rate of GDP growth causes inflation.

The RBI purchases or sells government securities through 'open market operations'. The purchase of government securities from the market participants by the RBI provides money to these participants. While when the RBI sells government securities to market participants, the market participants pay money to the RBI.

Over the past five years, the RBI has bought Rs 4.2 trillion worth of government securities. That is excess money floating around the system. To give you a perspective, Rs 4.2 trillion was 17% of the RBI's balance sheet over this period.

Now, the RBI is also buying foreign currency assets, primarily the US dollar. They bought roughly net US$62 billion over the five-year period, which was 21% of their total foreign currency assets.

Remember, when the RBI purchases dollars, it sells rupees. This puts even more money in the system, which fuels inflation. For the year 2014-15, the RBI purchased US$54 billion from the market.

When the rupee depreciates sharply, as it did from 2011 to 2013, the RBI is reluctant to sell its dollars to arrest the fall of rupee. That's because they fear erosion of their precious reserves. On the other hand, when the rupee consolidates or appreciates, the RBI immediately steps in and starts buying. This is a recipe for inflation.

The RBI tightened monetary policy over the past few years. So it can now afford a more 'accommodative' course since fiscal metrics are improving. The country's current account deficit has fallen to 22% from its peak of $88 billion in 2012-13.

Clearly, the central bank's words and deeds are not exactly aligned. Investors should never blindly believe any central bank's public pronouncements. Rather, pay attention to what is they do. As our governor himself says, words matter but so does intent.

In God We Trust. The rest we keep an eye on...

Rohan Pinto

Rohan Pinto (Research Analyst), Managing Editor, ValuePro and Smart Money Secrets, holds a bachelor's in engineering and a master's in finance. He is a practitioner of value investing philosophy inspired by Warren Buffett and Charlie Munger. Being a voracious reader, Rohan believes in the philosophy of mastering the best of what other people have already figured out. In his pursuit of worldly wisdom, he has constructed a multidisciplinary mental models framework, which he believes aids in effective decision making. His search for outstanding stocks is driven by a relentless pursuit of learning from the greatest living investors and the eminent dead.

Equitymaster requests your view! Post a comment on "Is the RBI Stoking Inflation?". Click here!

2 Responses to "Is the RBI Stoking Inflation?"

Viswanath

Jun 6, 2016

So everyone is looting the public including the RBI. Till now i was thinking it is only the Government but now RBI is competing with the Govt for looting/supressing the economy.

Like 

Ajit Kumar L

May 30, 2016

There is also an issue of policy transmission. Have a look how the yields on G-Secs moved in the last one year vis-a-vis repo rate cut by RBI. After the rate cuts last year, there were apprehensions of fiscal deficit, and after the initial period, yields have actually hardened. Later it started moving in tandem only after the signals from the government was clear in the Budget. And in a scenario where interest rates are moving down, there is need for a neutral stance on liquidity, (or even slightly surplus). That explains the stance of RBI on liquidity, OMO etc. No doubt, there could be challenges on inflation, but other favourable factors should help.

Like 
  
Equitymaster requests your view! Post a comment on "Is the RBI Stoking Inflation?". Click here!

More Views on News

These Stocks Have Rallied Over 300% In the Last 12 Months. Is the Rally Justified? (Views On News)

Nov 12, 2021

As many as 150 stocks from the BSE 500 index deliver multibagger returns in the past one year.

Ultimate Guide to Hedging Your Portfolio (Fast Profits Daily)

Sep 21, 2021

How can you protect your portfolio in a market crash? Find out in this video.

Ride the Indian Real Estate Revival with this 'Different' Smallcap Stock (Profit Hunter)

Mar 23, 2021

Affordability in the housing segment has never been so good in last one and a half decade. Here's how you could make the most of it...

My Latest Stock Recommendation (Fast Profits Daily)

Oct 9, 2020

How I picked an exciting stock using trends from both the commodity and equity markets.

Data is the New Oil but It's Also the New Sugar. Here's How to Fight it (Profit Hunter)

Jun 1, 2020

Is too much data hurting your quest for market beating returns?

More Views on News

Most Popular

Infosys vs TCS: Which is Better? (Views On News)

Nov 26, 2021

In the post pandemic era, the top two IT companies in India are fighting to capture the growing demand for IT.

6 Popular Stocks that Turned into Penny Stocks (Views On News)

Nov 27, 2021

A look at popular stocks that crashed big time and never recovered, i.e. which went from 'Multibaggers to Multibeggers'.

India's Top 5 Monopoly Stocks to Watch Out for (Views On News)

Nov 30, 2021

These 5 companies dominate their sectors with a huge piece of the pie.

The Biggest Winners and Losers in India's Transition to Electric Vehicles (Profit Hunter)

Nov 26, 2021

How India's EV transition could be a major headwind for the incumbents.

7 Stocks that Mutual Funds Can't get Enough of (Views On News)

Dec 1, 2021

Come hell or high water, these are the top Indian stocks which mutual funds never leave.

More

Become A Smarter Investor
In Just 5 Minutes

Multibagger Stock Guide 2022
Get our special report Multibagger Stocks Guide (2022 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

MARKET STATS