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.
Beating inflation is a tightrope walk - Outside View by S.S. TARAPORE
 
 
Beating inflation is a tightrope walk

This is not the time for RBI to relent on interest rates. That may ratchet up inflationary expectations all over again

The recent abatement of the year-on-year Consumer Price Index (CPI) inflation rate to below 7 per cent has generated a chorus of pleas from India Inc for a reduction in Reserve Bank of India (RBI) policy interest rates. Adding grist to the mills is Finance Minister Arun Jaitley's clarion call for a reduction in interest rates.

This is most unfortunate. So far, the NDA government's stance had been that interest rate policy was the prerogative of the RBI.

The inflation battle

The history of India's battle against inflation is replete with instances of taking the foot off the brakes just as the RBI is about to slay the 'inflation monster', thus giving it a breather to claw at the entrails of the economy.

When inflation touches double digits, the RBI is severely criticised for having let the genie out of the bottle and there is all round support for inflation control.

But as inflation falls below 7-8 per cent there is a clamour for a reduction in interest rates. It is not appreciated that a premature drop in policy interest rates does not provide an appropriate stimulus to kick-start the economy.

Interest cost is, generally, about 10 per cent of total cost and a one percentage point reduction in interest rates brings down overall costs of production by 0.1 per cent.

By lowering policy interest rates prematurely, all that happens is that banks cut deposit rates and savers are encouraged to shift from financial savings to physical savings.

The banking system has ample liquidity and credit expansion is unduly low (less than 2 per cent on a year-on-year basis) essentially because real sector activity is low.

A cut in interest rates, far from providing a kick-start to the economy, merely gives the inflation rate a kick up.

The new normal

If the RBI prematurely gives up the battle against inflation while it is in the 6 per cent range, the economy gets conditioned that inflation in the region of 6 per cent is the new normal and this is precisely how inflation at each successive surge becomes higher and higher.

Some years ago the RBI would consider that an inflation rate of 6-7 per cent was too high and the tolerance level was considered as 4 per cent.

If the RBI now gives up the battle against inflation at the current level, the next round of inflation will reach stratospheric levels.

It is not for nothing that in the early 1980s, when former Prime Minister Manmohan Singh was governor of the RBI, he had said that the governorship of the RBI was the loneliest job in India.

Hence the RBI has to steel itself to relentlessly fight the battle against inflation and not give up prematurely.

If it signals that it has started backing off from its anti-inflationary stance at a higher threshold, inflationary pressures will get entrenched and it will become virtually impossible to eradicate inflation from the system.

It is important that economic agents get the signal that the RBI has an unequivocal, unswerving, anti-inflationary monetary policy.

Opinion-makers have been showing greater maturity than hitherto.

The inflation monster

It is recognised that the recent fall in inflation rate is largely in food and fuel prices which could very easily reverse. Further, there has not been a demand compression.

Moreover, the decline in inflation is due to the base effect which will soon wear off and that could result in a resurgence in inflation. Again, the US Fed will, at some stage in the ensuing months, step up interest rates.

This will result in capital outflows from India. If the RBI reduces policy interest rates now, the increases in RBI would need to be steeper when the Fed increases interest rates.

There is also the possibility of crude oil prices rising, in which case the burden on the Indian fisc could be heavy.

In the event of a widening of gross fiscal deficit, it would not be feasible to ease monetary policy. As such, it would not be appropriate to ease monetary policy.

Even among the EMEs the Indian inflation rate is an outlier. As such the RBI should not risk a reduction in policy interest rates in the ensuing few months.

As the Indian psyche finds a sizeable depreciation of the rupee vis--vis the US dollar unacceptable, this would be inconsistent with an easier monetary policy.

For all these reasons a prudent monetary policy would point to the RBI not reducing policy interest rates on December 2, 2014.

I will never tire of repeating ad nauseum the telling statement made by economist PR Brahmananda, a former president of the Indian Economic Association: "Not caring about inflation is like going into battle without caring about the wounded, the dying and the dead."

Please Note: This article was first published in The Hindu Business Line on November 14, 2014.

This column, Maverick View is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Freepress Journal, is titled Common Voice.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

 

Equitymaster requests your view! Post a comment on "Beating inflation is a tightrope walk". Click here!

  
 

More Views on News

How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

Jun 10, 2017

Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

You've Heard of Timeless Books... Ever Heard of Timeless Stocks? (The 5 Minute Wrapup)

Aug 19, 2017

Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.

Why NOW Is the WORST Time for Index Investing (The 5 Minute Wrapup)

Aug 18, 2017

Buying the index now will hardly help make money in stocks even in ten years.

Trump Takes a Beating (Vivek Kaul's Diary)

Aug 18, 2017

Donald J Trump, a wrasslin' fan, took a 'Holy Sh*t!' blow on Tuesday.

How To Read Your Mutual Fund Account Statement Correctly (Outside View)

Aug 17, 2017

PersonalFN simplifies the mutual fund account statement for you.

More Views on News

Most Popular

Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

Aug 7, 2017

The data tells us quite a different story from the one the government is trying to project.

A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

Aug 10, 2017

Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

Aug 8, 2017

Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

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.

7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

Aug 7, 2017

Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

More
 

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

S&P BSE SENSEX


Aug 18, 2017 (Close)

MARKET STATS