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RBI’ Revenge

Posted by fairval on October 28, 2017

India’s real interest rates are at rates rarely, if even, seen in its history. Why does RBI not lower rates? Revenge for getting screwed on Demo?

When demonetisation (DeMo) was announced by Prime Minister Narendra Modi (NaMo) in a dramatic press conference on 8th November 2016; several commentators said it was a bad move. The subsequent shoddy implementation and its inability to reveal any immediate black money – notes came back into the banking system – heightened the criticisms. Today, almost one year down the line, it is almost universally acknowledged that DeMowas a failure.

While the NDA government has faced flak for it, the central bank Reserve Bank of India (RBI) has faced even more criticism. When DeMo was announced, RBI had just passed under a new leader. The resignation was the previous governor – posterboy Raghuran Rajan (RR) – was mourned by many. Experts said NaMo had let RR go because he wanted a pliable chief. RR had crossed the line by making political observations; he was giving indications of being anti-NaMo.

When DeMo was announced, the experts immediate said ‘RR wouldn’t have done it’. The new RBI governor immediately became painted as a sinner; someone who sort of lowered the independence of the RBI. The ‘experts’ were also clear – from now on, RBI would dance to the tunes of the government.

Well, a year since DeMo, nothing of that sort has happened. RBI refuses to dance. Despite a slowing economy, and hugely comfortable inflation situation, RBI refuses to lower interest rates. The result – India’s real interest rates are at levels perhaps never seen before in Indian history.

Remember India has always been a high inflation country, and for most parts, we have operated in zone of negative real rates. But now, our real rates are above 4.5%. While one has not seen history of real rates since last few decades it is likely these levels could be all time high. When economy has clearly slowed, should they be so high? This level is also much higher than other countries (see chart below)

RBI.png

The Economic Survey (vol 2) released in Aug’17 by Ministry of Finance has a detailed section explaining the situation on real interest rates and suggesting how much should interest rates go down. Says the Survey – Cyclical conditions, then, suggest that the policy rate should actually be below—not 50-100 basis points or so above—the neutral rate. The conclusion is inescapable that the scope for monetary easing is considerable, more than that suggested by comparison with neutral interest rates.

So why is RBI not listening? Is it the RBI trying to leave no doubt in anyone’s mind about its independence? Or worse, is it trying put the government down for destroying its reputation with Demo? RBI’s revenge?

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2 Responses to “RBI’ Revenge”

  1. adios said

    so is this a policy error?

    • fairval said

      Frankly am no expert on monetary policy. But what the finance ministry seems to be pointing out is (there is a detailed discussion in Economic Survey) – that as per method being currently followed by RBI, there is scope to cut policy rates by anywhere from 50bps to 100bps. So it is either differing interpretation of policy, or RBI sees inflation spike coming ahead, which most people can’t; or simply RBI is trying to prove a point on its autonomy to the government.

      The other point is – economy has slowed for 2 quarters. So if you don’t cut now, when? RBI should be ahead of the cycle, or atleast with it. Seems to be lagging.

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