RBI in a dilemma, again

Fri, 14 Jun Pre-Open

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The Reserve Bank of India's (RBI) dilemma is back again. Should it cut interest rates or maintain status quo? On one side, India is displaying signs of a major slowdown with industrial & manufacturing activity and overall growth levels at multi-year lows. As such, boosting growth seems to be the need of the hour. And one way of doing so is by cutting interest rates. This action would bring down the cost of funds and encourage investments. On the other hand, RBI's long fight with inflation kept it from easing rates for a long time. RBI waiting about three years before beginning its rate cut cycle at the start of FY12.

The sharp depreciation in the Indian Rupee makes decision making quite difficult for the RBI now. This is because a weaker rupee would increase inflation rates. As reported on NDTV's website, India's whole sale price index has a weightage of 35% on global commodities. Also, India's battle with the high current account deficit - the difference between a country's total exports and its total imports - has been going on for a while. Being a net debtor to the world is certainly not a position any country would like to be in as it leads to weakening of its currency. As such, with the Rupee depreciating it would not only widen the deficit, but also lead to further weakening of the currency.

The RBI did intervene in the forex markets by selling dollars and buying Rupees to avoid further depreciation. While this may support Rupee for the time being, India's forex reserves might get depleted to some extent. Also, this action would be one that would only have short term effects. As such, the country obviously needs more viable long term solutions. And that, we believe would only be possible by making changes in policies to attract foreign investments. Supporting the Rupee over the long term would be possible by higher foreign capital inflows, which should be the government's focus in the short to medium term.

In any case, the rate cuts have been something that investors have been looking out for a while now. With companies battling slowdown over the past few years, a lot of short term funding requirement were met through debt. And with the RBI beginning its interest rate cutting cycle, it was expected to have a twin effect on companies' numbers. One would be from the demand side, as the investment cycle and consumer buying - as mentioned in the article posted by NDTV, the Indian currency's fall would be bad for new homeowners given that the chances of any cuts seem low - would pick up. Second would be the lower cost of debt leading to lesser interest costs and higher profits. However, given these circumstances it only seems that these expectations will be deferred.