Can inflation concerns be curbed?

Mon, 31 Mar Pre-Open

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The RBI governor has received a lot of criticism for not lowering interest rates. Critics are of the view growth has not been his priority. Dr. Rajan had clearly explained the basis of his stance for not reducing interest rates; which is that interest rates in the country are based on inflation levels. And only by bringing down the latter, the reduction in interest rates will take place in the future. He was of the view that the probability of banks cutting interest rates - despite the RBI cutting rates - was minimal given the high inflation levels prevailing in the country.

Today, the RBI will be issuing its first bi-monthly monetary policy statement for financial year 2015.

In the past two monetary policy announcements, the RBI had taken a pause and hike respectively. In the month of December 2013, the central bank held rates. A month later, the repo rate was increased by 25 basis points to 8%. As pointed out by the Mint recently, during both of these policies, the key area of concerns remained the same - that of slowing growth the risks posed by the external environment.

In recent interviews, Dr. Rajan had mentioned that there is no trade off between the inflation and growth; and that inflation is simply hurting growth. And only when the former is brought down, will the latter expand.

While inflation has shown signs of cooling off in recent times, it still remains above the comfort zone of the central bank. And this has been despite the slowing economy numbers. In essence, the concerns now are more to do with whether inflation will continue to move in the desired direction.

What actions the RBI will take in the coming few months will be watched closely. With a number of factors such as the outcome of the elections , new government's actions and decisions and possible concerns of the El Nino in the current financial year , the outlook is unpredictable; and these concerns cannot be overlooked. In our view, given the circumstances, the possibility of the RBI lowering interest rates seems minimal.

Also as the business daily pointed out, in an environment when global interest rates are rising or are expected to rise, India's lowering of interest rates could possibly take its toll on the seemingly improving macro conditions like CAD and hence, the stable rupee.

We believe, the best strategy for investors would be to stay away from companies with leveraged balance sheets as that would curb all concerns related to interest rates movements. As we have been mentioning, all of such concerns would be mitigated when you stick to companies that have an inbuilt inflation beating mechanism - pricing power. Combine that with return ratios well above the cost of funds and you should do well as businesses with such characteristics do curb all inflation related risks.