To cut, or not to cut, that is the question: for the RBI Governor

“Whether 'tis nobler in the mind to suffer
The slings and arrows of (outraged industrialists and analysts),
Or to take arms against a (policy-paralysed government)
And by opposing end them…..” (with due apologies to William Shakespeare).

It wouldn’t be at all surprising if the RBI Governor is thinking like Hamlet prior to the policy announcement on Jun 18 ‘12. On the one hand, the abysmal IIP figure of 0.1% raised hopes of an interest rate cut among various stock market participants, who went on a buying spree. On the other, rising inflation poured cold water on rate cut expectations, and the stock market tanked.

 

What is so great about an interest rate cut, and why are market participants getting swayed by opposing possibilities? There was a greater–than-expected 50 bps (0.5%) repo and reverse repo rate cut in April – what happened after that? The stock market dived in May! Even if there is a 25 bps or 50 bps rate cut in June, it is highly unlikely that the sluggish economic growth engine will suddenly spring back to full speed.

 

Rate cuts tend to have a lag effect on the economy. Only after several rate cuts can one expect the captains of industry to start investing again and revive stalled expansion projects. Also, rate cuts alone can’t stimulate the economy. The government has to play an enabling role by cutting wasteful expenditure on subsidies and populist programmes, and make it easier for entrepreneurs and businessmen to start and expand businesses by reducing red tape and corruption.

 

From one extreme of doling out coal blocks and mining rights to all and sundry after duly lining their own pockets, government mandarins have gone to the other extreme of not sanctioning anything because they are afraid of being put behind bars on graft charges. Where bold policy decisions are the order of the day, senior ministers and opposition members are turning themselves into a laughing stock by their idiotic bickering and posturing over who will become the next President of India.

 

The great Indian growth story is being stymied by self-serving, thick-skinned representatives of the people who think it is their birth-right to loot the country’s resources. And they have the gall to blame the RBI Governor because without growth there will be no new projects, and without new projects the politicians can’t make money!

 

The RBI Governor should stick to his guns and conscience (he seems to be the only one with a conscience) and not succumb to any pressure about cutting interest rates in June. In fact, if inflation continues to rise – which is a good possibility because of the delayed monsoon – he should raise rates.

 

Will that be bad for the stock markets? Sure it will. The market seems to have factored in some sort of a cut – either in the interest rate or the CRR. Leaving rates unchanged may be taken as a negative.

 

Investors should take the motto of the Boy Scouts to heart: Be prepared. A drop below 4700 on the Nifty would provide a good buying opportunity. A spurt to 5200 can be used to sell.