Friday, October 10, 2008

Should The RBI Cut Rates?

The TOI today carries an interesting poll question; Should India follow the US and the EU and cut rates. I am not too sure the ayes and the nays generated from such polls carry any weight, but the question is nonetheless thought provoking. Should we follow suit? Here are a few reasons why we should NOT FOLLOW SUIT;
1. For starters, the real sector in India is not facing recessionary expectations as the real sector in the US is; the US is hardly keeping up to its 2 % GDP growth whereas we are relatively beter off even with the revised conservative estimates of say around 7%. Rate cuts make sense in a recessionary universe to try and up the growth; Our real sector (with the exception of Realty, where prices were due for correction anyway) are doing well.
2. We should be vary of inflationary pressures; yes, even with crude showing a downward bias in recent times, we are not out of the inflationary rut. Inflation demands monetary tightening to the extent possible , because injecting liquidity in the market means more money chases limited supply of goods, we are better off without the rate cut for now. the CRR cut of 50 basis points ( that will be effective from the week starting October 11th), is good for now. Indirectly, it creates liquidity and therefore incentives demand and that has positive implications for growth. Think this should be enough for now.
3. We should be conservative so far as financials are concerned for now; rate cuts might make the Share holders of the ( battered) Banking Cos. happy and a HDFC or an ICICI scrip may look up, but that might lull the banks in to lending aggressively ( in order to cover up the earlier losses), that way the Economy risks accumalation of bad debts in the longer run. We are nowhere nearer to having a good bankruptcy law in plac; So it is better to play safe than sorry.
4. The Fed Res policy of cutting rates has more to do with bridging the trust deficit that has manifested in recent times than with sound fundamentals; the catch is, if they dont do anything about the meltdown, Bernanke would be "Nero who fiddled while Rome burned"; So, they should be seen to do something to shore up growth. On the other hand, the Fed Res has only limited space in manipulating this policy tool ( the threat of Inflation rules out cuts in the 0- sub zero range). Its more to invoke a " At least they tried" response from the tax payer, who is ultimately goin to bear the burden. We are better off without following this inarticulated measure; (the truth is, the Fed Res should sit back and let the loss lie where it should. The FDIC and not the Fed Res should be more of a player these days in the US).
Let us see what the new Governor does; He is not seen to be as conservative as Mr. Reddy was; Am punting on a status quo though
Ciao for now!

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