Slide - 1: 2009. Between March 2010 and October 2011 The Reserve Bank Raised Its Policy Repo

Slide -1
India, though initially somewhat insulated from the global developments, was
eventually impacted significantly by the global shocks through all the channels
trade, finance and expectations channels. In response, the Reserve Bank swiftly
introduced a comprehensive range of measures to limit the impact of the adverse
global developments on the domestic financial system and the economy. The
Reserve Bank, like most central banks, to augment domestic and foreign currency
liquidity, sharply reduced the policy rates.
Towards managing the crisis, the Reserve Bank had lowered the repo rate by 425
basis points, the reverse repo rate by 275 basis points and the CRR by 400 basis
points over a period of about seven months between October 2008 and April
2009.
Between March 2010 and October 2011 the Reserve Bank raised its policy repo
rate 13 times by a cumulative 375 basis points. The policy repo rate increased from
a low of 4.75 per cent to 8.5 per cent. Still it did not help contain inflation. The
critics of the Reserve Bank argue that monetary tightening rather than lowering
inflation has slowed growth. Interest rate is a blunt instrument. It first slows growth
and then inflation. But the growth slowdown has not been commensurate with
inflation control.
In 2012, Reserve Bank of India kept its policy repo rate unchanged at 8 percent and
left the cash reserve ratio for banks at 4.75 percent.
At that point It was the right decision from the Reserve Bank of India's perspective
because a significant portion of the slowdown in growth was because of supply
constraints, and a cut in monetary policy rates or even the cash reserve ratio is not
going to make much impact on growth.
However it did change its stance on liquidity; it increased the limit of export credit
refinance from 15 percent of outstanding export credit to 50 percent- this, according
to the RBI is an additional injection of liquidity amounting to 300 billion rupees or
approximately 50 bps of CRR cut. The RBI also maintained that management of
liquidity remains priority and it will continue to use OMOs (open market operations)
as and when warranted to contain pressures.
The effect of this was that bond prices and stocks dropped and the rupee weakened
against the dollar after the decision surprised markets that had been expecting the
central bank to loosen policy.
By the end of 2014, the wholesale price inflation rate turned zero in November,
following dramatic fall in fuel and food prices, cementing expectations of an early
interest rate cut by the Reserve Bank of India (RBI) to stimulate the struggling
economy.
Problems of Deflation
Discourages consumer spending. When there are falling prices, this often
encourages people to delay purchases because they will be cheaper in the
future.
Increase real value of debt. Deflation increases the real value of money and
the real value of debt. Deflation makes it more difficult for debtors to pay off
their debts. Therefore, consumers and firms have to spend a bigger
percentage of disposable income on meeting debt repayments.
It leads to fall in wages and also means higher unemployment.
Despite fears of deflation and pressure from the government for monetary easing
Rajan did not cut interest rates in December14 with the repo rate remaining
unchanged at 8%.
To some extent, lower than expected inflation has been enabled by the sharper than
expected decline in prices of vegetables and fruits since September, ebbing price
pressures in respect of cereals and the large fall in international commodity prices,
particularly crude oil. These disinflationary pressures led the RBI to describe the
domestic economy as "subdued".
Now on 15th Jan 2015, Encouraged by softening inflation, the Governor Raghuram
Rajan-led RBI decided to cut the benchmark interest rate by 0.25 per cent to 7.75
per cent with a view to boost economic growth. Tumbling oil prices and lower food
costs have hardened speculation that more reductions in rates will follow.
Households inflation expectations have adapted to single digits for the first time
since September 2009.
Opinions:
This rate cut will help improve investor sentiments as cost of finance is an important
factor for giving boost to the industrial sector. FICCI president
Although this is a positive news for markets, there still remains some questions
around this minute cut on its transmission mechanism to the end borrowers. Also,
the economic recovery has been shallow with no significant effects felt on the
streets, suggesting banks may still be cautious. All said, the business cycle can
benefit significantly if the RBI pursues this stance with further sizeable cuts and an
expansionary monetary policy in the months to come.
The interest rates should be based on inflation and the Governor believes that the
inflation is not controlled as yet and the time is not right for reducing benchmark
rates. His belief is that even if the rates were brought down, it might not stay low
due to inflation concerns and could only result in market volatility. RBI's stated role
is not controlling inflation or prices (which they leave to the government) but to
control the volatility.
With the rate cuts people expect banks to lend more which would in turn increase
consumption, industrial investment and provide an overall boost to the economy.
http://www.dnaindia.com/money/report-how-does-rbi-s-rate-cut-impact-you-2052700
http://www.financialexpress.com/article/economy/rbi-cuts-rate-india-inc-reacts-saysexpects-more-down-the-line/30269/
http://www.bloomberg.com/news/articles/2015-01-15/india-unexpectedly-cuts-ratesin-unscheduled-review
http://www.financialexpress.com/article/economy/rbis-raghuram-rajan-effects-slrrate-cut-all-you-need-to-know/38567/
http://articles.economictimes.indiatimes.com/2014-11-08/news/55894210_1_rbigovernor-raghuram-rajan-central-bankers-more-stimulus - central banks around the
world

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