Can RBI policy fuel the market?

The only question today everyone in the market is asking themselves is what is that they aren't able to see which the Reserve Bank of India (RBI) governor is seeing which is restricting him from cutting interest rates. On Tuesday, August 4, 2015, RBI will announce its monetary policy. According to a latest Reuters poll, 47 of the 51 economists surveyed are of the view that RBI would keep key rates unchanged.

Two years back RBI governor when he took over was applauded for his efforts to control inflation and twin deficit. Then crude oil was trading around $110 per barrel, inflation (WPI) between 6 and 6.5 per cent and food inflation nearly at 10 per cent. Then expectations were global energy prices would head towards $120 per barrel and agri-commodity prices globally would further scale higher. Though there were a few that were not happy with RBI's decision of tightening of rates as they felt applying breaks could derail the growth momentum, but majority of the experts were in complete sync with RBI of tightening the rates.

But today things are different with global energy prices having crashed. The crude oil (below $50 per barrel) prices have fallen along with inflation. With the new supplies from Iran and increase production from Saudi Arabia are expected to keep energy prices lower than expected. Second in India the WPI index is trading negative for the last seven months and CPI index has eased to its historical lows. In such an environment everyone from India Inc to bankers to market to government are wondering why RBI governor is not obliging by cutting rates.

Some concerns that may be still hovering and reasons restricting the RBI from cutting rates could be monsoon, strengthening of the US dollar on expectations of US Fed increasing rates and rise in spending and expenses of Indian government. Last week government announced banks recapitalisation to Rs 20,000 crore from the earlier budgeted Rs 7,940 crore for FY2016. Meanwhile increasing government wage bill will also remain a concern. Estimates are even without previous arrears the absolute increase in total monthly salary can be more than double that in 6th pay commission. The wage bill could put pressure on the government balance sheet and in turn putting pressure on inflation due to an increase in consumption.

One theory is RBI governor hawkishness seems to be influenced by Paul Volcker who is widely credited with ending the high levels of inflation seen in the US during the 1970s and early 1980s. Though Volcker was credited to kill inflation in US, the aftermath was followed by recession in the US. Things don't look similar in India but the fact is there isn't any reason for Corporate India to operate in the current environment. Excluding banks, IT and oil & oil marketing companies, the 300 odd companies among the top BSE 500 companies have witnessed a return on equity (ROE) falling to a low of 11 per cent as on FY2015, compared to 22 per cent as on FY2008. Though the government is recapitalising select banks and is spending in infrastructure the pain in the system is not going any time soon.

Comparing the US and Euro-zone, majority of experts are of the opinion of going the Keynesian way rather than the Milton Friedman's. Keynesian economist believes in consumption, government expenditure and net exports to change the state of the economy, which the US has adopted. While the Milton Friedman's theory is to control the supply of money, this is believed to be the strategy in the Euro-zone. So far RBI has successfully used the control of money supply and government expenses, but with growth slowing down law makers today seem to be going the spending way to fuel growth in the country. In fact in a recent presentation by Kotak Mutual Fund it said RBI governor is like Arjun from the great epic Mahabharata. He is only targeting inflation just like Arjun was only targeting the eye of the fish. But India wants Krishna who can give a holistic view which would also focus on growth.

The dilemma of growth and inflation will remain. With the government still not been able to take care of the supply side, the concerns over inflation will remain, but for a country like India which is consumption led it is important to keep fuelling the engine of growth. Foreigners are also looking for growth markets to invest and India is best placed to take advantage of the foreign flows if it is able to keep the growth momentum. Meanwhile this week equity market would keep a close eye on the RBI governor's speech as to what will be his future stance on interest rates, inflation and growth.