New Delhi: The Reserve Bank of India decision to keep interest rates unchanged is a message to the Indian government to get things in order. There are multiple factors that influence RBI’s decision.
Here are five things that could help you comprehend the RBI stance:
Inflation, inflation and inflation: The inflation beast is not easy to tame. The wholesale inflation rate is well above 7.5 per cent. Central banks have a primary job of controlling the inflation in an economy. RBI monitors the trajectory of core inflation. What this means in simple terms is that the central bank plots the monthly inflation data on a graph. If it points up north consistently then RBI has no room to cut interest rates. Primary food articles inflation rose from negative [(-) 0.7 per cent)] in January to 10.7 per cent in May largely due to a sharp increase in vegetable prices. Protein inflation continued to be in double digits. “Notwithstanding the moderation in core inflation, the persistence of overall inflation both at the wholesale and retail levels, in the face of significant growth slowdown, points to serious supply bottlenecks and sticky inflation expectations,” RBI said in the statement.
Government expenditure: By not touching rates, RBI has told the government to get its house in order. “The decision was based on the premise that the process of fiscal consolidation critical for inflation management would get under way, along with other supply-side initiatives,” RBI said in its statement. The central government has been living beyond its means for some time now. The fiscal deficit is likely to be 5.5 per cent of gross domestic product or GDP despite international easing oil prices, according to rating agency ICRA. This is effectively the amount of money the government borrows from RBI to meet annual expenses. Tax revenue could fall short of the budgeted level while inflows of non-tax revenue like telecom spectrum and disinvestment depend on market conditions. The risk of the government borrowing rising is very high. RBI has told the government in no uncertain terms that rate cuts are not possible if the government does not cut the overall borrowing.
Subsidies: RBI has urged the government to cut subsidies on fuel. “The consequent subsidy burden on the Government is crowding out public investment at a time when reviving investment, both public and private, is a critical imperative,” RBI said in its statement. Budget estimates put subsidies at Rs 1,90,000 crore for 2012-13. They account for a third of the government borrowing or the fiscal deficit. RBI has told the government clearly that it needs to borrow less so that money can be made available for businesses to stimulate growth.
Slow growth not because of high interest rates alone: The high government borrowing hurts the so-called liquidity or money supply as RBI has to meet the government borrowing demand ahead of businesses. As the government borrows more, it increases the cost of borrowing for small and large businesses. RBI estimates suggest that real effective bank lending interest rates, though positive, remain comparatively lower than the levels seen during the high growth phase of 2003-08. “This suggests that factors other than interest rates are contributing more significantly to the growth slowdown,” RBI said on growth slowdown.
Guidance: RBI will monitor the inflationary trend going forward. In its statement, RBI says that core inflation has moderated, reflecting demand conditions and lower pricing power. However, the central bank is concerned about wholesale and retail inflation rates rising which have a bearing on inflation expectations. “Future actions will depend on a continuing assessment of external and domestic developments that contribute to lowering inflation risks,” RBI said in the statement.
Here are five things that could help you comprehend the RBI stance:
Inflation, inflation and inflation: The inflation beast is not easy to tame. The wholesale inflation rate is well above 7.5 per cent. Central banks have a primary job of controlling the inflation in an economy. RBI monitors the trajectory of core inflation. What this means in simple terms is that the central bank plots the monthly inflation data on a graph. If it points up north consistently then RBI has no room to cut interest rates. Primary food articles inflation rose from negative [(-) 0.7 per cent)] in January to 10.7 per cent in May largely due to a sharp increase in vegetable prices. Protein inflation continued to be in double digits. “Notwithstanding the moderation in core inflation, the persistence of overall inflation both at the wholesale and retail levels, in the face of significant growth slowdown, points to serious supply bottlenecks and sticky inflation expectations,” RBI said in the statement.
Government expenditure: By not touching rates, RBI has told the government to get its house in order. “The decision was based on the premise that the process of fiscal consolidation critical for inflation management would get under way, along with other supply-side initiatives,” RBI said in its statement. The central government has been living beyond its means for some time now. The fiscal deficit is likely to be 5.5 per cent of gross domestic product or GDP despite international easing oil prices, according to rating agency ICRA. This is effectively the amount of money the government borrows from RBI to meet annual expenses. Tax revenue could fall short of the budgeted level while inflows of non-tax revenue like telecom spectrum and disinvestment depend on market conditions. The risk of the government borrowing rising is very high. RBI has told the government in no uncertain terms that rate cuts are not possible if the government does not cut the overall borrowing.
Subsidies: RBI has urged the government to cut subsidies on fuel. “The consequent subsidy burden on the Government is crowding out public investment at a time when reviving investment, both public and private, is a critical imperative,” RBI said in its statement. Budget estimates put subsidies at Rs 1,90,000 crore for 2012-13. They account for a third of the government borrowing or the fiscal deficit. RBI has told the government clearly that it needs to borrow less so that money can be made available for businesses to stimulate growth.
Slow growth not because of high interest rates alone: The high government borrowing hurts the so-called liquidity or money supply as RBI has to meet the government borrowing demand ahead of businesses. As the government borrows more, it increases the cost of borrowing for small and large businesses. RBI estimates suggest that real effective bank lending interest rates, though positive, remain comparatively lower than the levels seen during the high growth phase of 2003-08. “This suggests that factors other than interest rates are contributing more significantly to the growth slowdown,” RBI said on growth slowdown.
Guidance: RBI will monitor the inflationary trend going forward. In its statement, RBI says that core inflation has moderated, reflecting demand conditions and lower pricing power. However, the central bank is concerned about wholesale and retail inflation rates rising which have a bearing on inflation expectations. “Future actions will depend on a continuing assessment of external and domestic developments that contribute to lowering inflation risks,” RBI said in the statement.
