Interest rates: the case for status quo:Business LIne 26th October 2013

The RBI has taken a fairly one-dimensional stance on monetary policy in the last couple of years by linking it to inflation rather than growth. The concept of inflation has varied from generalised WPI and CPI inflation to more specific indices such as core and food inflation.

With the WPI and CPI inflation numbers coming in higher for September, there is a natural expectation that the central bank will increase rates on October 29.

However, there are compelling reasons to believe that the RBI will adopt a neutral stance this time, given the singular conditions that we are witnessing.

INFLATION OUTLOOK

First, while inflation has been higher in September, there is reason to believe that prices would move downwards from October onwards, since we are expecting a good kharif crop which should lead to tempering of food prices. This being the case, a final decision can be deferred for the next policy in case inflation does continue to increase.

As monetary policy is ideally forward-looking, waiting for another month and a half will not do much harm.

Second, the government has been talking of pushing personal loans through incentives such as additional capitalisation for banks beyond the Rs 14,000 crore budgeted for the year.

Some banks have taken the cue and lowered interest rates during the festival season ostensibly to encourage borrowings which will boost consumption.

This being the case, increasing interest rates by the RBI will send confusing signals to the market.

As we are working towards pushing forth demand for consumer goods, status quo in repo rate can be justified.

Besides, as we are banking a lot on the spending cycle being rejuvenated this season, increasing rates at this time will spoil the party. Third, the rupee has become stable in the last month partly due to strengthening of fundamentals, with trade deficit coming down and FIIs in equities turning positive.

Therefore, there is less compulsion to increase rates now to defend the rupee as the internal forces are working well.

In fact, the MSF rate could be lowered this time by 25 bps, as it does appear that the MSF rates were tinkered with keeping the exchange rate in mind while the repo has been sued more for signalling policy stance, with focus on inflation.

BEST OPTION

Last, the Finance Minister has been reiterating that interest rates should come down and even recently has urged banks to lower their lending rates.

With such pressures being exercised, the RBI will probably pay some heed to this concern, and while it may not be possible to lower the rate given that inflation has been rising, a compromise would be to leave rates unchanged.

Therefore, it does appear that a status quo on interest rates would be the best option given that there is lot of hope that the festival season will be associated with more consumer spending and lower inflation.