RBI Hikes Rates: Monetary Reasoning

RBI monetary policy committee (MPC) unanimously decided to increase the benchmark repo rate for the first time in more than four years, in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 % within a band of +/- 2 %.

The rate changes after the MPC meet will be:

1.      Under Liquidity adjustment Facility(LAF) decided to raise Repo rate by 25 bps to 6.25%,
2.      The reverse repo rate under the LAF stands adjusted to 6.0 %, and
3.      The marginal standing facility (MSF) rate and the Bank Rate to 6.50 %.

Stance: Neutral

A neutral stance provides the Reserve Bank of India enough leeway to change rates in either direction in the next MPC. RBI Governor Urjit Patel said, “The MPC felt there was enough uncertainty to stick to neutral stance and yet respond to the risks to inflation target that have emerged in the recent months.”

A Rate hike was expected, but many experts felt that RBI might wait till the next MPC meet to hike Rates. This rate hike is being treated by some as a pre-emptive strike to insulate from the event risk on inflation in the future.

The major factors taken into account by the committee on deciding for a Rate hike were:

1.      Rising inflation concerns: The committee expects retail inflation at 4.8-4.9% in the first half of the year and at 4.7% in the second half of the year. Retail inflation, which is targeted was 4.58 % in the month of April, driven by a significant increase in inflation excluding food and fuel.                                                                                                                                (source: RBI)

2.      Global Factors: Global trade growth has continued to strengthen, though geo-political tensions contributed recently to declining export orders.  In Advanced Economies the Global economic activity has expanded albeit some momentum has been lost; Emerging Market Economies have generally been resilient. Oil prices increased for some period and the due to supply glut more or less stabilized.

3.      US Rate Cuts: This has increased the pressure on the Indian Rupee. Also, bond yields have risen on reduced foreign appetite for Emerging Markets debt due to growing dollar shortage in the global market and on prospects of higher interest rates in Advanced Economies. Stocks in major EMEs have faced sell offs on a rising dollar.

4.      Liquidity Surplus: During April, the Reserve Bank absorbed surplus liquidity of ₹496 billion on a daily net average basis due to increased government spending, especially in the second half of the month.

5.      Rural Demand: Improved rural demand on the back of a bumper harvest and the government’s thrust on rural housing and infrastructure. The monsoon forecast augurs well for the agricultural sector. According to RBI, October seems more likely by which better information about the impact of the MSPs on food prices can be gauged. As forecast by the IMD, if the monsoon is normal and well-distributed temporally and spatially, it may help keep food inflation in check.

Ripples: Demonetisation, Trump and OPEC Part-2

 This blog post is part of the series on "Ripples: Demonetisation, Trump and OPEC". To read the previous part click here. This post was written in collaboration with  Akansh Gangil and Shikhar Bansal.

 Trump election and failure of Analytics

The election of Trump as the next President of the United States came as a shocker for many. The various pre poll surveys and analytics failed to predict his victory. Trump has campaigned on a slogan of "Make America Great Again" by announcing to do away with past economic policies of the US. His policies of first 100 days will have huge implications on global economy and polity.

The good news can start with US growth, which might accelerate above the 2.2% average annual rate. Trump may implement the Keynesian fiscal stimulus that Obama often proposed but was unable to deliver.

Trickle Down Economics

Mr Trump proposed to cut taxes dramatically. His tax cuts would mostly benefit the rich, which would limit the boost to demand somewhat, but a large increase in the government deficit could not help but give a jolt to the economy. At the same time, Mr Trump seems likely to increase spending on defense and on infrastructure (and, possibly, on a wall, which would seemingly count as both).

Decrease in corporate taxes will help mainly the service sector and not the manufacturing sector. As the taxes are lowered, more disposable income will be available with individuals which will raise the inflation levels, which even though desired, leading to raising the already high wages. Thus labor cost will remain as the major hurdle for manufacturing growth.

 Shift in Trade Policies

 During the presidential campaign Trump has repeatedly called for repealing or renegotiating the trade deals.

 This adamant attitude towards US participation in blocs like NAFTA, TPP  and TTIP will adversely impact automotive industry all over the world as import duty on automobiles and auto-parts, coming from Japan, China and other countries, will increase by a large margin. Consequently the big OEMs (Nissan, VK, BMWs, Ford) and their suppliers manufacturing outside the US might shift their manufacturing plants to US. But, as already discussed, labor cost will make manufacturing costly, thereby leading to price rise for SUVs, Trucks and as well as cars.

 Geopolitical Issues

Mr. Trump being the next commander in chief has to tread very carefully as geopolitical tensions can rise by any impulsive move from his side. And tensions among nations is always bad for business( other than defense suppliers). US position on critical international issues like climate change can change. The US stand in various international forums on climate change will need to be carefully analyzed. 

 It is hard to know or anticipate how he will use the army, or the diplomatic machinery of the American government. Any move toward greater conflict in the Middle East or Asia could have serious economic consequences: from soaring oil prices to market panic to interruptions in global trade. The economic and human costs of war are impossible to anticipate but frightening to consider.

Indian Perspective

Perhaps the most negatively impacted industry will be IT as more stringent laws and higher cost for H1B visas seems to be  in the offing. This will considerably increase the cost for IT companies. Apart from trade, the diplomatic position of US towards Pakistan and China will also have huge implications on Indian trade and international policy making.

Whether we like it or not, Donald Trump is set to be the US President and his policies are bound to create Ripples.