Active Stocks
Tue Mar 19 2024 12:01:03
  1. Tata Consultancy Services share price
  2. 4,019.80 -3.01%
  1. Tata Steel share price
  2. 148.50 -0.74%
  1. Bharti Airtel share price
  2. 1,233.55 0.69%
  1. Power Grid Corporation Of India share price
  2. 260.20 -1.81%
  1. ITC share price
  2. 409.65 -1.86%
Business News/ Market / Mark-to-market/  Structural problems can’t be fixed with cyclical tools
BackBack

Structural problems can’t be fixed with cyclical tools

Why monetary policy has a limited role to play

The Reserve Bank of India had little choice in reducing the repo rate by 25 basis points on Tuesday, if it didn’t want growth expectations to plummet. Photo: Pradeep Gaur/Mint (Pradeep Gaur/Mint)Premium
The Reserve Bank of India had little choice in reducing the repo rate by 25 basis points on Tuesday, if it didn’t want growth expectations to plummet. Photo: Pradeep Gaur/Mint
(Pradeep Gaur/Mint)

The Reserve Bank of India (RBI) had little choice in reducing the repo rate by 25 basis points on Tuesday, if it didn’t want growth expectations to plummet, while the cut in the cash reserve ratio (CRR), the RBI governor has said, was to ensure that banks reduced their lending rates.

But the problem is that inflation may have become structural, for the following reasons:

1) Food inflation remains high and the RBI has said on many occasions that it’s the result of increased purchasing power among the rural poor. This keeps inflationary expectations high.

2) Wage inflation in rural areas remains high. This is due to spending on social security, on rural infrastructure and make-work programmes such as MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act). Since a large part of these are doles, they do not add to productivity.

3) Administered prices have remained suppressed for so long that there is now no alternative but to raise them, for items such as coal, fertilizer, diesel and electricity.

4) Raising agricultural support prices is a political imperative.

5) The high current account deficit leads to downward pressure on the rupee, which, in turn, leads to higher import prices.

6) There are bottlenecks in coal production, iron ore production, power generation and issues in land acquisition that will limit the supply side response, while the need to curtail the fiscal deficit will mean that a big push to infrastructure spending by the government is unlikely in the near future, in spite of the government’s best intentions.

7) A high level of stressed assets will mean a cautious approach to lending by banks, which, in turn, could inhibit the supply side response.

8) High inflation has led to people moving funds to non-financial assets, such as gold. This has fuelled gold imports and exacerbated the current account deficit, which reduces the value of the rupee, adding to inflation.

9) The current account deficit is also being exacerbated, RBI points out, because “constraints in the availability of key raw materials and intermediates are becoming binding". Imports have become less sensitive to prices due to supply side constraints in fertilizers, coal and several other commodities.

10) The slower growth of financial assets, including bank deposits, will constrain the ability of banks to lower the deposit rate, which, in turn, will limit reductions in their lending rates.

The upshot: monetary policy has a very limited role to play under these circumstances.

Why has RBI’s first repo rate cut in 9 months failed to galvanize the markets? TakeMint poll here, and tell us what do you think.

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 29 Jan 2013, 05:38 PM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App