RBI's latest measures to stimulate growth

A quick take on the current events including the RBI's latest move today to cut CRR, SLR and repo rates.

It is now very well known that there is a real threat of recession in the world economy. At least its biggest component is facing that. The United States' economy contracted by 0.3% in 3Q2008. Officially, it has another quarter to post negative growth to qualify as a recession. But, that is only a technicality. With the world financial markets already in their worst crisis in ages, it is only a matter of when, not if, it will happen. Though it is much more complex, to summarize - the world financial turmoil initially led to a liquidity crisis. Liquidity crisis (will lead) to less spending. Less spending to (an eventual) recession. The recession (threat has already) led to unwinding of bullish positions in commodities (all types - agricultural, metals, and crude oil). Unwinding has in turn led to crash in prices. Though some may say the bubble has burst there, the stocks of commodities even after their discounted prices are quoting at extremely low valuations (this can be taken as a separate blog topic later).

Now coming back to India, the inflation which had shot up to over 12% in late September / early October is now easing a bit. It is thanks to the substantial softening of global commodities that the inflation has eased. With the industrial output now almost kissing the zero growth mark due to the hard stance taken by the RBI in the past 1 year to choke liquidity in order to rein in its biggest enemy at that time - inflation. Having realized its goal, the RBI is now simply reversing the process to stimulate growth, though the magnitude of measures taken can definitely be called 'historic'. In a span of 20 days, the CRR was cut by 350 basis points to 5.5%, the SLR by 250 basis points to 24%, and lately the repo rate by 150 basis points to 7.5%. This has lead to a release of 270,000 crore rupees to banks to lend. Such a measure is unprecedented. Business Standard says that previous biggest move was a 2% CRR cut way back in 1974. Though the inflation is in double digits currently, the RBI seems to be pretty confidant that it will ease considerably as inflation follows price patterns (not lead). The soft commodities, especially crude oil, is not factored in yet. Of course, it is the government that takes the pricing decisions there - but the petroleum minister, Murli Deora, left no time to announce a price cut if crude oil falls below 61 USD a barrel (when it was still hovering above 70 USD to a barrel). Crude oil price have a chain effect. So, that gives the RBI a cushion in the coming weeks with regard to inflation. The extra liquidity released today is expected to ease the pressure in the call money markets immediately where nobody seems to trust everybody else and hence the high rates being quoted (as high as 21%). In the medium-term, this measure and the reduced repo rate signal reducing interest rate environment. Though the real interest rates are still in the negative, this move will be welcomed by all the bold folks out there hunting for new homes, cars, holidays, etc. in these testing times. However, this is subject to the bankers having mercy on them and passing on the benefits.