Will the RBI give a boost to the economy?

RBI maintains status quo on key interest rates in today’s policy review. As discussed earlier events trigger momentum and another such event has taken place today outcome of this was on expected lines. The RBI has not increased key interest rates. Market consensus was inclined towards neutral to positive direction of interest rates in terms of making more money available to the people. Release of money or an increase in liquidity in the market fuels economic growth activity.

 

Lower interest rates or falling interest rate scenarios always augurs well for equity as well as debt markets. As interest rates fall, funds become available at cheaper rates and enables people to get credit for buying certain things, which they would not have been able to earlier. For example falling interest rate scenario makes home purchases more affordable and available to more number of people. This not only helps the housing sector, but with new homes people tend to buy other things which a new home requires such as furniture, electronics, and home textiles. With a rising demand for homes, the demand rises for construction sectors as well, such as cement and steel.

 

Why then hasn’t the RBI lowered interest rates in the past?

The RBI couldn’t lower interest rates in the past due to one major reason, inflation. In the last RBI policy though, the increase in interest rate which RBI was carrying on for some time now has paused. This was largely due to a fall in inflation in the past few months.

 

What’s the inflation trend currently?

Indian annual inflation rate slowed to a 25-month low at 8.1% in February, 2014. Provisional figures showed that vegetables prices eased for most part of the year. Food prices decelerated to an annual 8.57%, down from 9.9% in the previous month. Cost of fruits recorded the highest growth rate (15.79% versus 15.66% in January), followed by vegetables (14.04% versus 21.91% in January). Cost of sugar fell 5.48 percent during the year and oils and fats dropped 1.17 percent. Prices of clothing and footwear grew slightly by 0.04 percent to 9.22 percent and prices of fuel and light lowered to 6.13 percent from 6.54 percent in January.

 

Provisional annual inflation rates for rural and urban areas in February are 8.51% and 7.55%, respectively.

 

The CPI (Consumer Price Index) inflation rate in India was recorded at 8.10% in February, 2014. The CPI inflation rate in India averaged 9.76% from 2012 until 2014, reaching an all time high of 11.16% in November, 2013 and a record low of 7.55% in January, 2012.

 

Historically, the wholesale price index (WPI) has been the main measure of inflation in India. However, in 2013, the governor of The Reserve Bank of India, Mr. Raghuram Rajan had announced that the consumer price index is a better measure of inflation.

 

Inflation History year on year (YOY)

CPI – Annual inflation (Dec.)

Inflation %

Change (YOY %)

2014 (Feb)

8.1

(11)

2013

9.1

(18)

2012

11.2

72

2011

6.5

(31)

2010

9.5

(37)

2009

15.0

54

2008

9.7

76

2007

5.5

(16)

2006

6.5

17

2005

5.6

47

2004

3.8

2

2003

3.7

16

2002

3.2

(38)

2001

5.2

48

2000

3.5

640

1999

0.5

(97)

1998

15.3

144

1997

6.3

(40)

1996

10.4

7

1995

9.7

2

1994

9.5

CPI – Consumer Price Index

 

The above table shows CPI inflation history in India. Since 2010 CPI inflation remained almost below 8%, except in the year 2012. The sudden rise in inflation and a downfall in currency have forced the RBI to increase the benchmark interest rates (Repo / Reverse Repo).

 

Recently, we have seen considerable fall in the WPI inflation (below 5%) as well as the CPI inflation (8.1%). CPI inflation has fallen by 18% in 2013 and by the 3rdmonth of March, it has already been down by 11% over the previous year’s figure.

 

Balancing Economy

RBI has to maintain a balance between inflation and interest rate so that consumer prices aren’t out of reach of the common man. Too much inflation in the economy is bound to affect it adversely, resulting in a gradual fall in economic growth.

 

Falling interest rates scenario supports equity as well debt market. With a continued momentum in the equity markets, participants are more convinced that the RBI is likely to keep interest rates unchanged or may opt for small cuts in interest rates.

 

These expectations are also building in the equity and debt markets. The 10 year G – sec bond yield is trading lower at 8.8% while the Sensex is trading near its all time highs.

 

 

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The Industry is urging for a cut in interest rates as there has been a considerable fall in demand due to high interest rates, as seen in the past few months in segments such as the auto sector. Bank stocks have improved their position in the past few months, on the expectations of a pause in the interest rate hike and a possible cut in the coming months, supported by new norms on banking licenses that are expected to come into the picture.

 

As expected the RBI’s action has not harm either the equity or the debt markets; rather it will support the present momentum in the market. This presents a pretty good picture for investment and investors needs to work towards building a healthy investment portfolio, with ideal asset allocation across equity and debt products.

 

 

Happy investing…

Manish Tawde
Product Research & Financial Planning

 

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

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