Friday, January 25, 2019

To cut or not to cut


Some food for thought
"The first qualification for a historian is to have no ability to invent."
—Stendhal (French Writer, 1783-1842)
Word for the day
Adrenalize (v)
To stir to action; excite
 
Chart of Day

 To cut or not to cut
Persistently lower than RBI target headline consumer inflation numbers and recent prints of poor IIP/PMI data have prompted a few economists and analysts to seek rate cuts in next MPC meet on 07 February 2019.
In my view, these are unreasonable wishes and MPC may in its collective wisdom not oblige those seeking easing of monetary policy at this juncture.
Firstly, I believe that irrespective of the government's optimism and maneuvering, the fiscal gap for FY19 and FY20 may stay above the expected level of 3.3%. In the event of political uncertainty post elections in May 2019, it may actually end up even higher than 3.5% as decision making would suffer and GDP (the denominator) may log lower growth.
Secondly, the contribution of exports in the GDP growth has declined materially in recent quarters. Given that the energy prices have started to rise and current account concerns are emerging again, it may not be advisable for INR to let appreciate disproportionately, which might be the case if rates are cut at this juncture.

 
Thirdly, the credit growth has been quite robust in past one year, whereas the deposits have been declining. More significantly, credit in the riskier segments like personal loans, MSME etc. is rising even faster. Primary principle of economics suggests that price of anything is function of demand and supply for that thing. Since, at present the demand for money is much higher than the supply, the price of money (interest rates) should logically stay higher.
Fourthly, the rising rates in US have already led to some unwinding of USD carry trade, leading to outflow of portfolio funds. A further rise in rate differential could accelerate the outflows even further, creating panic in financial markets, at a time when liquidity is already tight.
Lastly, the whole perception about the lower inflation may be misplaced. The core inflation on both WPI and CPI measures has been running much higher than the headline numbers.
 

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