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Monetary Policy August 2nd 2017
Big day today in the history of Indian Economy because the Monetary policy created a record today. Heartfelt congratulations to the Indians because the central bank of India that is RBI has cut interest rates by 25 percent to bring it to 6.00% which is the lowest in 6 ½ years. A Big achievement and economy well in course of growing big. Celebrations can begin, people can enjoy. Maybe after reading this post completely….
Let me take a minute and explain a little about Monetary policy. Monetary policy is a process by the which central bank of the country controls the supply of money by doing various activities which are related to demand and supply creation. Most important factors taken into consideration are Inflation and Production. In India RBI is the authority which holds responsibility of Monetary policy, this monetary policy can change the game of growth to huge extent for any country. India has system of Bi-monthly monetary policy which means six policies in a year.
Now about the D-Day Monetary Policy that happened today on 2nd August 2017!
The base interest rate of India now stands at 6.00% which as I said earlier is 6 ½ years low figure. Such big thing that India has achieved and we all should be proud of that fact. Now you can have lower Home Loan interest rates, Lower EMI’s and so on … What if I say this is all something that had to happen almost 10 months ago which means 5 policies ago in October 2016.
Yes, you heard it right. The rate cut that was to come way back in October 2016 has come today and clearly Markets were in no mood to accept this fact and saw a fall end at of the day. That also means the growth of India for 10 months is now gone for toss. We start all over again.
Mr. Governor – Urjit Patel
Mr. Governor you have given lame reasons for not giving rate cut all this while and today when you give rate cut to make up for the messed-up situation. Are you given that role to ponder over past events or to predict future and act accordingly! You spoke about increasing inflation and you see that inflation never hit 4% and today it is 1.5% and that is when you wake up or is this realization after Government hammering you for your dumb decisions taken in last policy. Other reason you talk about is the crude oil hitting 60$ which looks like a far stretched dream of yours.
Now after giving a small rate cut of 25bps which is of no use you talk about 18-24 months inflation and vegetable prices. When the policy decisions are taken looking at 2 months past data how are you balancing it with next 2 years?
People may enjoy this cut and celebrate it but I am bitterly disappointed and feel sad for Government and people of India for having a person like you as Governor.
Inflation – Inflation, as everyone understands, is the key economic term which talks about the gap between supply and demand. The rate of inflation for example at 4% means the price of products will go up by 4%.
Inflation is again of two types they are
CPI – Consumer Price Index – Inflation that is measured at the point of Purchase.
WPI – Whole Price Index – This is the supply side Inflation where it deals with measuring the inflation at the point of production.
CPI figures come out at 3.65% for the month of Feb-17 which looks decent and under control of RBI but consider the point that CPI last month was at 3.17%. Keeping aside CPI for some time let’s move onto WPI. WPI numbers come at 6.55% for Feb-17 which is the highest in last 18 months. The gap between the CPI and WPI inflation is 2.88% which is a very big difference for any country.
Always for the economy, CPI is found to be more than WPI but for last few months, the WPI in India is found to be more than CPI.
So, which is better?
CPI greater than WPI or WPI greater than CPI.
WPI as understood is the supply side inflation where it decides how much to produce based on demand. The increase in WPI inflation means actual supply is lesser than the expected supply. The reasons are completely depended on the economic conditions at that time. CPI inflation is higher when there is not enough supply to meet the increasing demand.
To understand it clearly supply happens in the form of production and moves to the point of purchase that is CPI. If there is a change in the demand that increases the inflation in CPI. The increased demand triggers increase in supply at WPI and keep the inflation at WPI lower. So, a higher CPI always encourages higher production and higher production triggers higher GDP growth.
A Higher WPI inflation means lower supply and the lower supply means lower growth and lower GDP.
How do you increase the Supply?
Your supply will be more when the interest rates are lower. This is because at the lower interest rates the cost of production will be lower and you can make profits by producing more. So, WPI should always be lesser than CPI.
But Why WPI came at 6.55% and CPI came at 3.65%? Whom to Blame?
This is because of no rate cut decision was taken by RBI in the last monetary policy. RBI did not go for a rate cut and lost the chance of increasing the supply. The reason is RBI was worried rate cut would increase the demand at CPI. This will further increase the inflation if supply doesn’t go up. But now also inflation is increasing from WPI side because of lack of supply.
Thus, RBI not decreasing the interest rate did not serve the purpose.
What should be done on next RBI policy on 5th April?
I want RBI to wake up and cut the interest rates by least 50basis points. This decreases the interest rates to 5.75%. It will also boost the stock market which is at an all-time high. RBI should stop worrying about Crude oil prices and demand worries.
To conclude Nifty has already reached its all-time high after Modi wave in UP elections. Now it’s the time to take it to a higher level by improving the macroeconomic fundamentals. If this happens I’m sure we will celebrate this Diwali with a 10,000 on Nifty.