X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Why the RBI must lower interest rates? - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Sep 21, 2007

    Why the RBI must lower interest rates?

    The RBI's frank account of the key challenges that are to be faced by the Indian economy in the coming months, present the rationale for the central bank's guidance of a slowdown in the growth trajectory. But again, it also offers scope for improved performance.

    Barring supply shocks of the kind brought about by a bad agricultural season, or some natural disaster, the Reserve Bank of India (RBI) expects the real GDP to grow by 8.5% YoY in FY08. It is unequivocal in its stand of controlling headline inflation (as measured by the WPI) to below 5% (currently a benign 3.5%) for the rest of FY08. Global factors like any further hikes from the already high level of prices for international crude oil, so required to fuel India's growth, can also skew the picture. All of RBI's monetary targets for FY08, like bank credit growth of 22% to 23% are based on these premises.

    However, a permutation of some of the key factors impacting credit growth based on forward estimations - generates some interesting conclusions.

    What lies ahead?
    FY91 - FY00 FY01 - FY07 FY03 FY04 FY05 FY06 FY07
    Real GDP growth (%) 5.7 6.9 3.8 8.5 7.5 9.0 9.4
    Bank credit growth (%) 15.9 21.4 16.1 15.3 27.0 30.8 28.0
    Multiplier (x) 4.3 1.8 1.2 2.6 1.6 1.1 1.3
    Money supply growth (%) 17.2 15.8 12.7 16.7 12.1 17.0 21.3
    Inflation (WPI, %) 5.5 4.8 3.3 5.5 6.5 4.4 5.0
    Source: RBI Annual Report 2007

    GDP growth
    Bank credit, forming 52% of GDP in FY07, has closely traced the growth of the Indian economy in the past. Infact the multiple of bank credit growth to GDP is taken as a lead indicator of the future credit expansion. With a slowdown in the average GDP growth to 8% over the next two fiscals, the slowdown in bank credit is pertinent.

    Inflation
    Inflation too plays a crucial role in supporting the growth momentum of the key industrial and service sectors (together about 82% of the GDP). While low inflation would lead to excess money supply and restrict flow of credit to the productive sectors, a shoot up in the same hampers growth of productive sectors for want of capital. Coupled with average 8% GDP growth, the inflation rate of 5% would help the nominal GDP grow by 13% over the next two fiscals.

    Credit-GDP Multiplier
    The best yardstick of 'productivity', the multiplier, which is nothing but the ratio of incremental GDP (or GNP at market prices) to incremental credit growth, has averaged at around 1.8 times in this decade. The multiplier increases with higher GDP growth and restricted capital flow, while it shrinks with increased credit expansion. Assumption of average GDP growth of 8% and inflation of 6% gives us a multiplier of 1.3 times. However, with this assumption, the incremental bank credit growth falls below the targeted 20% YoY. A low multiplier would therefore be necessary for the RBI to achieve its credit growth targets.

    Retail credit - The Joker in the pack!
    Thanks to a surge in credit to retail sectors, the multiplier dropped from 2.6 times in FY04 to an average of 1.3 times over the last three fiscals. In FY07, while 36% of the incremental non-food credit was absorbed by industry and another 14% by agriculture, personal loans absorbed 24%. The share of housing loans in personal loans on an incremental basis averaged at 48% over the last two fiscals. The retention of the high growth rate in credit to retail sector, thereby keeping the multiplier below 1.5 times, will be a decisive factor to ensure that the incremental credit growth does not fall below 20%.

    How do the interest rates play a role?
    Looking back, the reason for the surge in retail credit over the past few fiscals were the low interest rates and an easy monetary policy. The sustenance of the same will be inevitable if the gradual moderation in credit slowdown is to be effected as against a sudden drop. Given that opting for higher inflation would be unaffordable for the central bank due to political and economic factors, keeping the interest rates benign seems to be the only way out. This calls for the RBI to adopt a softer approach in its interest rate policy (though not with the intention of aping its US counterpart). The timing and nature of the same is best left to the seasoned mentors of the monetary policies.

     

     

    Equitymaster requests your view! Post a comment on "Why the RBI must lower interest rates?". Click here!

      
     

    More Views on News

    Insider Leaks Equitymaster Stock Picks (The 5 Minute Wrapup)

    Jul 25, 2017

    Equitymaster HQ has been infiltrated. Valuable stock ideas have been leaked. Who's responsible?

    Raymond and Other 'For Profit' Companies Who Don't Care about Shareholder Returns (The 5 Minute Wrapup)

    May 27, 2017

    What happens when minority shareholders are short-changed in the normal course of business?

    Why Commission Driven Model In Mutual Funds Should Be Eliminated... (Outside View)

    Feb 15, 2017

    PersonalFN believes SEBI has taken a step back-apparently in the admission of it going overboard with the regulations.

    This Book Changed How I Looked at the World of Man and Money (Vivek Kaul's Diary)

    Aug 24, 2016

    And here's your chance to claim a free copy of this book...

    The Developed World is Dying because of Demographics, Debt, and Deflation (Vivek Kaul's Diary)

    Aug 12, 2016

    And Why India's demographic dividend could turn out to be a doubtful debt...

    More Views on News

    Most Popular

    This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process)(The 5 Minute Wrapup)

    Aug 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.

    The Most Important Innovation in Finance Since Gold Coins(Vivek Kaul's Diary)

    Aug 10, 2017

    Bill connects the dots...between money and growth, real money and real resources, gold and cryptocurrencies...and between gold, cryptocurrencies, and time.

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    Bitcoin Continues Stellar Rise(Chart Of The Day)

    Aug 10, 2017

    Bitcoin hits an all-time high, is there more upside left?

    5 Steps To Become Financially Independent(Outside View)

    Aug 16, 2017

    Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

    More
    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.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. 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
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    MARKET STATS