RBI Rate Cut on 05-03-2009

On 4th March 2009, RBI was lowering the repo rate, at which it lends to banks, to 5.0 per cent from 5.5 per cent, effective immediately. It also cut the reverse repo rate, at which absorbs excess cash from the banking system, to 3.5 percent from 4.0 percent, effective immediately. The credit policy is reviewed based on the inflation numbers.

About repo and reverse repo click here

The details of inflation, inflation is calculated based on the WPI numbers inflation for weekend Feb 21 is 3.03% Vs 3.39%(WoW), it peaked around 13% in CY2008. If a interest rate falls it will take a long time for interest rate to move up.

On basis of the current inflation number easing, but when inflation is calculation is based on WPI, (wholesale Price index) and there is a mismatch in the reality and projection of WPI based inflation numbers. Leave aside the base effect for some time. WPI shows a decrease in price but its not visible accross the board except for petroleum product. Consider fall in petrol price should make the Rs/KM based cab charges or autos or taxis must also fall but its not happening. If you consider the food prices there is not match between inflation and prices across most commodities and services.

Is the WPI is the right index to measure the inflation ? If yes, so why is it very different from the reality. As WPI is taking all goods into account when compared with CPI. WPI index should be altered to reflect the right situation but not to project the imaginary.

While considering base effect, when there is a sharp increase in a index and a correction takes place it will obviously show a -ve growth for correction, consider a index of 100 number rose by 20% to 120 and by correction if it falls to 108 which is is still a 8% increase wrt 100 but same is -10% wrt 120 number. On a time line if the WPI due to a spike goes to 13% and when it is taken as a bench mark to compare it with the fall of spike gives a deflatory situation. Any policy making should consider these extraordinary condtions which project a deflationary times but its a high inflationary time when calculated for a longer period of time.

Coming to CPI (Consumer Price Index), inflation will be more than 15% (my expectation depending on food and essential articles). CPI gives the ability of the common man living conditions, with the inflation of 15% a man with Rs.10,000 income can survive easily if his expences grow from Rs.2000 to Rs.2300, but it will be hard for a person earning Rs.1000 and spends almost his income on living and he cann't be able to efford the rise in his expence but cut short his requirements and live below the previous living standard.

If rate cut is to increase economic activity it is well and good but this can lead to the problem of over spending and again inflation climbs up which is not intend of the monitory policy and above all rate cuts will not increase the economic activity. Instead rate cut must have been sectorial wise and not across the board similar to a fisical stimulus. Rate cut will make the banks to increase it business (revenue) due to falling interest rates to spur business and relax the rule to lend and this in turn create a bad debit. And India is a saving based economy this will turn into a punishment for the 80% of popualtion which saves.

As per many banker the liquidity is ample in the system and there is a lack of confidance to spending in a shrinking economy. For this, sentiment has to be boosted and not the interest rate cut, sentiment can only be boosted by support to job generating sectors like textiles, exports and manufactoring, etc., Infrastructure is required but this is not the time to make a blunder by following the history its time to innovate the policies and change the mind set and work for a better economy and lead the world to create a history. Its a good time for to work and create education and medical infrastructure under government for free education and free medical support as it is prevalent in developed countries, this will also create a a large number of employement than pumping money meaninglessly. Working on the needs of the requirement and job creation is required than following someone else who failed in every possible way.

Coming to liquidity pressure seen by corporates will not be easied so soon as many PE players are exiting the lending space due to lack of liquidity. No corporate is ready to get loan against the security and to be frank there is a huge gap between loan value and security valuation. The corporates know if they decrease the price they get the revenue and cash follow for sustaining but are reluctant for not lossing the profit they are not in a mind set to operate atleast in breakeven for some time and turn the things into there favour. I could like to add a sentence here " You are profititable when you buy low but not when you sell high".