Thursday, June 16, 2011

RBI raises repo and reverse repo rates - again

Most economists and stock market analysts were expecting RBI to raise the repo and reverse repo rates by 25 basis points (i.e. 0.25%). So, the markets should have already 'discounted' the interest rate hike. Then why did the Sensex drop nearly 150 points to slip below the psychological level of 18000?

Before I attempt to answer that question, a little digression.

Many Indian working/earning men have different types of addictions. Some are addicted to tobacco. Some like to go to the races. Others like to hit the bottle. All such addictions cost money. And that money comes off from the top - i.e. before the monthly expenses are incurred.

In other words, to feed the addiction, needed monthly expenses have to be curtailed. Which doesn't make sense to any one - except the addicted person. Month in and month out, he blows money up in smoke (or in torn race tickets, or in drunken stupors), while bills remain unpaid. And then, money has to be borrowed to pay the bills - making a bad situation worse.

The RBI is facing a similar predicament. Time and again, they have raised the repo and reverse repo rates in a graduated bid to curtail inflation without hampering growth. Without much success. In fact, inflation rate has started climbing again. Why? 

The global downturn followed by the massive money printing (better known as Quantitative Easing - Part 1 & 2) 'exported' inflation to the developing countries like India, by buying up stocks in better performing markets. The Indian government has continued with wasteful expenditure - better known as 'subsidies' - which inevitably doesn't benefit ordinary citizens
Vote bank politics ensured that required financial reforms and tough fiscal policies were avoided (or at best, not pushed through). Prices of diesel and kerosene have not been increased with the excuse that inflation will climb even higher. Nor have the punitive taxes on petroleum products been reduced, which could have partly mitigated the price hike.

Lot  of sound bytes have been issued about curbing black money generation and bringing perpetrators to book. The fact of the matter is that the few arrests in the various scams have only come about due to prodding by the Supreme Court. The government departments and the ruling party remain the biggest sources of black money generation. 

No concrete improvements will happen in transparency and governance till the elected leaders reform themselves. All the talk about identifying account holders in Swiss banks has led to some of the black money getting re-routed through 'hawala' channels back into the country - further stoking the fires of inflation - and into real estate deals. Probably the reason why debt-burdened real estate companies are refusing to lower the prices of apartments and buildings.

And food inflation? That can be eliminated in one simple step - by allowing FDI in food retailing. All the apparent concern about 'kirana' stores going out of business is nothing but crocodile tears. There are too many middlemen with close ties to the one in Power (pun intended). The humongous wastage will be eliminated through modern refrigerated storage and transportation facilities. Removal of middlemen will be a win-win for farmers and consumers.

Sorry about that long rant. The point is, without appropriate fiscal and policy measures to support the RBI's monetary tightening, inflation is not going to come down any time soon. That is what came out of the RBI's statement today. Which means more tightening and further increase in repo and reverse repo rates in future, while the governments 'addiction' remains uncured.

That is why the Sensex dropped. 


gupt said...

RBI is doing what it wants but the fact remains that inspite of increasing the rates the inflation is not coming down as is evident.

Does it not mean that RBI's actions are not in consonance with the real needs?


Subhankar said...

Thanks for the comment, Siddanth.

As an autonomous body, RBI can't sit back and allow rampant inflation. They are using the tools they have in their possession - which is raising interest rates and curtailing liquidity flow.

The government is letting them down by not taking proper decisions on financial reform and reducing wasteful expenditure.