27th October there is a half yearly review by RBI, and many surveys are coming out regarding the outcomes of that meeting. Yesterday or day before yesterday I read moody's report stating that RBI is going to increase the CRR by 50 basis points from 5% to 5.5%. CRR is Cash reserve Ratio, that is banks keep 5 rupee of every 100 rupee deposit with the central banker. Increasing CRR means slow sucking up off liquidity from the system. But is our economy ready or over heating by excess liquidity? No, I dont think so. Due to global financial meltdown RBI has reduced the CRR & repo from peak 9% to 5% & reverse repo from 6.5% to 3.25%. When Lehman Brother collapsed immediate next day itself call money rate went beyond 15% which was well above the RBI's repo & reverse repo corridor. From then RBI has gradually reduced all above mentioned rates to present ones.
Now question comes why people are expecting RBI to increase the interest rates? Its because of fear of inflation. Now again there is one more question, why Inflation will/is rising? Is it because of Demand pull (caused by increases in demand due to increased private and government spending, etc) or cost push (caused by a drop in aggregate supply)? Here in our case I can say both the reasons & in addition to that low base is also going to play major boost for incremental inflation.
Due to financial crisis, government has announced many stimulus packages & also 6th pay commission grants & etc helped the domestic demand intact. And due to poor monsoon & flood situation in some places food production is expected to hit hard rocks. So these two above lines cover demand pull & cost push reasons. And as I explained about many times how the base effect is playing major role in direction of the inflation.
But because of above reasons RBI should not rollback their policy decisions. Since even though ours is 2nd fastest growing economy our GDP fell from around 9% to 6% levels. Due to collapse many financial organizations & others, export declined continuously 8 months, according IIP data. The credit growth rate is around 20% from its peak of 30+% in 2004 & 25% in 2007 -08. So to roll back to dream run, we as country needs to monetary policy stimulus to continue till at least March 2010.
And due to FII (nearly US $14 Billion in last 6 months) & FDI inflow Indian Rupee is appreciating against the US Dollar. That is one good sign for importing companies, espeically oil importing companies since oil is the major importing goods. This makes the all importing goods cheaper & oil has some more than 15% weightage in WPI index according which weekly inflation is measured in India.
And according to economist James Tobin, moderate level of inflation can increase investment in an economy leading to faster growth or at least higher steady state level of income. This is due to the fact that inflation lowers the return on monetary assets relative to real assets, such as physical capital. To avoid inflation, investors would switch from holding their assets as money to investing in real capital projects.
Bottom line:
So instead jumping to reversing the monetary policies, RBI should give some more time to country to get back into fast track growth rate & then can think of increasing SLR, CRR, Repo & Reverse Repo in a sequential manner.
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