Will He Or Won't He Cut Interest Rates?

Will He Or Won’t He Cut Interest Rates?

 The recent Chinese interest rate cut to pump-prime its slowing economy, will also inject more liquidity into the global financial system.  The EU, teetering on the verge of negative growth, is also taking steps to introduce a stimulus. Japan already has. Some pundits feel that instead of raising interest rates in June 2015, the US Federal Reserve, finding domestic  growth too fragile, may instead reintroduce another round of quantitative easing (QE).

The near zero interest money, then, is going to remain plentiful, and be looking for growth opportunities across the globe.

Here in India, it is baffling how one august banker after another expects the RBI Governor Raghuram Rajan to not cut interest rates in December. This despite several well publicised urgings from Finance Minister  Arun Jaitley, the last of which specifically requests a rate cut in December 2014 itself.

If  Mr.Rajan holds out, as most private and public sector banks expect him to, he is ignoring the massive drop in inflation - thanks to the over $ 30 per barrel drop in oil prices.  And petroleum prices are not likely to revive any time soon, not only because global growth is muted temporarily, but also because there is a supply glut.  America, once a 50% consumer of international oil, is now self-sufficient. 

Jaitley meanwhile, has been making frequent announcements on the road to preparing his  second Budget to be presented in February 2015. He has promised ‘Second-generation Reforms’, starting with the Winter Session of Parliament, just commenced.

Of course, the celebrated  Governor Rajan is famous as the economist who foretold the global meltdown of 2008, three years earlier, in 2005. He also held his ground in the face of ridicule and withering criticism at the time. Rajan strongly disapproved of the Alan Greenspan style borrow and spend policies. He made his forecast at one of Greenspan’s retirement functions, when the iconic and long-staying Fed Chief was being feted for having contributed to years of roaring prosperity.

But as RBI Governor in India, Rajan contributed substantially towards stabilising a tanking rupee, and India’s yawning fiscal and current account deficits. This restoration of the value of the rupee has been nationally and internationally praised, and helped to bring in a flood of FII investment, now unafraid of the currency erosion risk.

Rajan, contrary to popular perception, has also been easing liquidity, albeit by agonising degrees. He has done the easing by means other than a straight interest rate cut. So, whatever happens in December 2014, and then in February, and again in April 2015, we can expect some reduction of the tight money pressure.

But, to be sure, the market, and the business community, national and international, want very much more. Some pundits have said that if the RBI refuses to cut interest rates by at least by 25 bps now, and at each two-monthly review; it will have to cut by a higher figure, in one fell swoop later.  Either way, the widely expected rate cuts next year, and in 2016, have been worked into the India calculation by many foreign investment firms.

Indian banks however, are far less gung-ho. This even as some, particularly in the public sector, led by the State Bank of India (SBI), are sitting on massive non-performing  assets (NPAs). They are also  disguising other doubtful loans on their books by rescheduling them.

Some of the remedy surely lies in a resumed investment cycle. Inflation is no longer raging. It is lower than it has been in years. To worry about whether it could rise again, if liquidity is eased, is denying  growth its due. How then, can the Indian investment cycle, dead in the water for several years now, be ignored any longer? 

The international investment community, on which this country’s development plans hinge, have faith that the investment cycle will be kick-started very soon - and start showing results within 18 to 24 months. They are putting their money on it. This is shown by a projected and unprecedented $ 40 billion FII investment expected this fiscal. This may not be big money in Europe or America, but is a great leap forward here.

This money, about $ 30 billion worth has come in already, despite quite severe caps in our Debt Market. India permits FIIs to buy only some 5% of our debt instruments, including Government bonds, compared to around 40% plus, in other countries of the Asian region, including Indonesia.

Of course, our authorities and policy makers fear ‘over exposure’ to global indebtedness, and prefer fiscal circumspection to GDP growth. But the Modi vision is transformational, and the old ways, turned impediments, will surely have to be thrown over.

 (777 words)

November 23^rd, 2014

Gautam Mukherjee