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The Reserve Bank of India is taking quite a gamble with India’s economic future

The Reserve Bank of India is taking quite a gamble with India’s economic future Shaun Richards

The Prime Minister of the UK David Cameron has just completed a state visit to India with the objective of boosting links between his country and its former colony. He may well consider how things and times change as it is India with its current estimated 5.5% economic growth rate (which it considers to be low!) which is far exceeding the UK’s flat-lining economic growth performance. UK readers may well be saying "about time" as they read this as their leaders have spent so much effort on a sclerotic and arthritic Europe and much less on parts of the world which are booming. However my emphasis in this article is to look under the bonnet of the engine of the Indian economy as not everything is working in tune.

If everything is going so well in India why are they easing monetary policy?

Economic growth is slowing even if it is still much much higher than the UK Prime Minister can dream of at home. From the Indian Ministry of Statistics.

Gross Domestic Product (GDP) at factor cost constant (2004-05) prices in 2011-12 is estimated at 52,43,582 crore as against 49,37,006 crore in 2010-11 registering a growth of 6.2% during the year as against a growth of 9.3% in the year 2010-11.

So slowing but still good even if there is a fall to the forecast of 5.5% for 2013.

What about inflation?

Again this is at a much higher level than you would associate an easing of monetary policy with.

Provisional annual inflation rate based on all India general CPI (Combined) for January 2013 on point to point basis (January 2013 over January 2012) is 10.79% as compared to 10.56% (final) for the previous month of December 2012.

Combining the two

If we add economic growth to the inflation rate we see that at somewhere between 16 and 17% a central bank would normally be pressing the brake and not the accelerator and some would be stamping on the brakes hard!

Instead we saw this from the Reserve Bank of India

We did two actions: we cut the repo rate by 25 basis points from 8% to 7.75% and the CRR (Cash Reserve Ratio held by banks) by 25 basis points also, bringing it down from 4.25% to 4% of NDTL (a measure of bank deposits).

Over to the Reserve Bank of India

We can find out why they did this if we look at the press conference the Governor of the RBI held with analysts. He gave three reasons.

So the first consideration was the decline in inflation. The second was clearly the deceleration in growth. And the third was the liquidity situation.

Does this wash in reality?

There is an obvious issue with cutting interest rates when consumer inflation is so far above the official interest rate. After the move we see that consumer inflation is currently above the new interest rate by 3%. So with interest rates in real terms currently -3% quite a stimulus is being applied unless you expect inflation to fall quickly and heavily. Also in the same conference we do get something of a contradiction from the Governor.

"a number of upside risks to inflation"

Most importantly, the suppressed inflation that will come off coal prices, electricity prices might be adjusted in the next few months

Also the Governor was challenged on this point as shown below.

"We have inflation expectations of 12% three month forward and 13% for one year forward and these have been pretty sticky for the last two years and it seems to me that these inflation expectations have become quite unanchored in India."

If we move onto the secondary influence which is economic growth there is a slow down expected but is the RBI really saying that an annual growth rate of 5.5% is one which require stimulating?

Next we will find a familiar themes from the blogs of mine that you may have read and it is that economic policy across so much of the world appears to be set for the benefit of the banking system! We get a long explanation of why not only interest-rates needed to be cut but also why bank reserve requirements needed to be cut too. How convenient you may be thinking!

What about India’s trade deficit?

India has been running a considerable trade deficit which has been exacerbated by the way that the oil price has risen and also by the way the Rupee has weakened against the US Dollar. In the first half of the year it was 4.7% of her economy's size and the forecast for it is not hopeful according to the RBI’s Governor ( who is likely to be a professional optimist in such matters…)

The second half is likely to be higher and this year’s currency account deficit is likely to be significantly higher than last year’s current account deficit.


I have two thoughts for you. Firstly we may be entering a new paradigm where emerging and expanding economies have a different set of rules to the mature ones but can they be this different? Secondly if you add in the promises of further action the RBI has taken quite a gamble here but if it fails it will be the Indian population who will feel the pain.

Tags: Economy , future , India , Indian banks , Indian Budget , Indian economy , Reserve Bank of India
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  1. kimaya29 says:
    Sat Mar 02 14:43:54 GMT 2013

    I agree it is good to see some analysis of the Indian economy. As to events I see that the Indian government is going to cut the deficit by spending much more as Patrick has already said! On top of inflation and a trade deficit problem India is running many risks right now. This seems a reckless gamble.
  2. patricka says:
    Thu Feb 28 14:37:48 GMT 2013

    It seems that all sides of Indian economic policy are now expansionary. Todays budget talks of reining in the fiscal deficit but according to Reuters the reality is this. "Total budget expenditure will rise by an unexpectedly high 16 percent in the 2013/14 fiscal year to 16.65 trillion rupees" Inflation is indeed a danger which Indians may fear. Also it is good to see the Indian economy being given its due weight and being analysed

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