Dilemma for RBI continues: Should it focus on inflation or growth?

Dilemma for RBI continues: Should it focus on inflation or growth?

So far this year the Indian market has been third biggest gainer on the global MSCI Index gaining close to 17 per cent. India was only behind Turkey and Indonesia which gained 21 per cent each. It is all thanks to the strong and stable new government that has been set up at the centre. The market gained nine per cent in May 2014 alone.

Indeed, even before May 16 when the election results were declared, there had been a surge in the Indian market on the expectation that Narendra Modi would come to power. India under Modi is expected to be pro business, pro-growth and pro-reforms. There is a feeling that with Modi coming to power he will replicate the Gujarat growth model in the whole country by reviving demand and investment and putting growth back on track.

But it is not as if Modi has a magic wand that can stimulate growth from day one. Even if he takes the right steps it will take at least 12 to 18 months for the economy to come back on track. However hopes are that the worst is over for the economy and Friday's GDP data of 4.7 per cent for FY2014 is expected to be the rock bottom.

The real test and the next trigger for the market will be the Union Budget for 2014/15 which is expected to be announced by July.
 
The dilemma for the Reserve Bank of India (RBI) continues to be: should it focus on inflation or growth? In the past, the RBI has made it amply clear its primary focus will be curtailing inflation rather than pushing growth and that has been the reason why interest rates have been kept high. So far the RBI has not blindly the government diktat on key monetary policy decisions.

The Modi government's focus will be on development and growth which means interest rates will have to fall, making cheaper finance available to corporate India to increase investment and for consumers to increase demand.

But the RBI's hands are tied. It can't reduce key policy rates beyond 50 to 75 basis points as it has to keep a comfortable interest rate differential for foreigners to invest in India. Foreign institutional investments (FII) compared to foreign direct investments (FDI) is still dominant in India. Second, with the US quantitative tightening on track and the US Federal Reserve's decision to increase rates by the middle of 2015, the RBI will not have room for a drastic rate cut. In fact, if US increase rates, every country including India will have to increase rates.

Growth in the US still remains uncertain as it has so far been on easy money. It will be clear only after the quantitative easing (QE3) is over. Currently every month the US Fed is buying bonds worth $45 billion. So far no one has any clue as to how the US economy will react once QE3 ends by this year. The ghost of the Lehman crisis is still not over. There is no record in history of such crisis and therefore the beast is still unknown. Already the 10-year US bond has fallen to 2.45 per cent from 3 per cent in January 2014 on concerns that the US as well as the global economy is still limping.

The RBI and the Modi government would love the US economy to remain sloppy for some more time such that it has some room to bringing down rates. People's mandate is development and Modi government can't go back on developmental reform, but for it to succeed US and global economy will have to remain sluggish and focus on inflation will have to take a back seat.

Meanwhile on Tuesday, June 3, the RBI is expected to keep the key rates unchanged . Any further course of action from RBI will come after the US Fed meeting which meets on June 17 and 18.

- Business Today
Thanking you

Regards,

Rajesh Kumar Kathpalia ¤ SMC Global
17,Netaji Subhash Marg,Daryaganj,
New Delhi-110002 Mobile No 9891645052
Email Id: rajesh.ipo@smcindiaonline.com


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