Demystifying StocksRBI Credit Policy What to expect?

With the increasing inflation, it may be wise to expect that your day-to-day borrowing costs may not go down soon. Experts have begun to give their views on what the Reserve Bank of India should do on 30 October 2012 when it announces its credit policy.

RBI governor D Subbarao will convey the central bank’s stance on the country’s monetary policy. This policy controls the tap of money in the financial system. RBI lowers or raises borrowing rates.

Companies, individuals want RBI to cut the borrowing cost so that it puts more money into the hands of businesses and individuals. However, RBI has kept borrowing costs high in a bid to fight the inflation. It is important to know what RBI does this Tuesday, 30th October. It is also important to know why RBI is taking a specific stance.

Introduction

RBI’s main priority is to fight inflation. If inflation remains high, it eats into the growth of an economy. RBI is unlikely to lower borrowing rates if it feels that inflation is likely to remain high. The whole sale price or WPI inflation has stayed close to 7.8 per cent following fuel price hikes in September 2012. Estimates from analysts suggest that it could go well over 8 per cent. RBI plots monthly wholesale price inflation data on a graph. It looks at the trajectory or the direction of that graph. Currently, it is pointing upwards.

The Inflation Battle

Food Inflation

Even though interest rates are high, there is no sharp decline in the credit growth or the overall borrowing from banks. Till early October 2012, credit growth stood at 15.9 per cent.

The demand for credit is met by the growth in bank deposits. That was slower at 13.9 per cent. This means demand for money is likely to remain high.

RBI has to make money available. For the purpose, it may either cut borrowing rates for banks called repo rates or cut the cash reserve ratio or CRR, a portion of deposits that banks maintain with RBI.

Many expect RBI to cut CRR to ease the pressure on the financial system.

Liquidity in the financial system

The way the government manages its budget makes a significant difference to the interest rate scenario. If the government expenditure is more than revenue, it borrows money from the RBI. This borrowing is the government’s fiscal deficit. Media reports suggest that the RBI governor D Subbarao is concerned about the Indian government’s fiscal deficit for the full year 2012-13.

The April-August 2012 central government expenditure rose 19.7 per cent, according to the government data. The budget estimates for this is 14.8 per cent for the full year 2012-13. “Government spending accelerated to 32 per cent in August over last year even as gross tax revenue growth slipped to 7.9 per cent,” said an analyst at Morgan Stanley, a global bank in a note.

This means RBI would look at how the government manages to control expenditure for the balance year as it is already spending more than expected.

Fiscal deficit

The rising fiscal deficit does not allow RBI to cut borrowing rates for corporates and individuals. This is because it becomes a priority for RBI is to make money available to the government over businesses and individuals. This results in borrowing costs for businesses and individuals to go up. This is typically called ‘crowding out of private investment’. If businesses or individuals cannot get cheap money, they put expansion on hold. They cut spending. This results in fewer jobs being created in the economy and hurts the growth. Hence, one needs to watch out for RBI’s commentary on the outlook for growth.

Stimulate growth

The monetary policy statement of RBI is worth reading for the commentary on the outlook for the economy and monetary policy. RBI’s assessment gives a complete picture of the state of the economy.

For a stock market investor, this becomes a lead indicator for future growth. If RBI hints at reducing rates consistently going forward, it means borrowing cost for companies could go down. Over the past three years, businesses have incurred 40 per cent more interest burden as RBI hiked borrowing rates 13 times since March 2010. In April 2012, it cut borrowing rates by 0.5 per cent.

If borrowing costs are reduced further, they would directly improve prospects for growth and profitability of businesses.

The Outlook

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