The Fed effect and the RBI’s dilemma

NEW DELHI,OOMMEN A. NINAN:Scheduled banks see little possibility of easing their lending rates, following Reserve Bank of India’s (RBI) decision to keep repo rates unchanged at 6.50 per cent in its Second Bi-monthly Monetary Policy Statement, 2016-17 last week.

RBI Governor Raghuram Rajan.

Hence, the common man’s woes continue as the burden of borrowing for his assorted needs such as housing, education, vehicles et al remains unchanged.

Even though the rates were gradually reduced by 150 basis points from its peak of 8 per cent in January 2014, the scheduled commercial banks are yet to pass on the repo rate reduction benefits fully to borrowers in the retail segment.


The Policy Statement has noted that incoming data since April 2016 has shown a sharper-than-anticipated surge in inflationary pressures due to a jump in prices, despite it being off-season, of food items such as vegetables, fruits, sugar, meat, fish, edible oils, spices and non-alcoholic beverages.

Clothing and footwear also registered moderate increases in inflation.

“While the upper-class remains largely unaffected as far as the rise in prices of the essential commodities is concerned, the middle and the lower classes crave for better control on the price increases which disturb their day-to-day budgets,” said Kumar Saurabh Singh, Partner, Khaitan & Co, India’s oldest and largest full-service corporate law firm.

Nonetheless, RBI appears to be optimistic that a strong monsoon, continued astute food management, as well as steady expansion in supply capacity, especially in services, could help offset these upward inflationary pressures.

Tepid expenditure

“The banking sector and their retail costumers, therefore, expect change in the next few quarters. So, the later half of the year may see easing of prices if there is no unexpected turn of events globally,” said Mr. Singh.

In the short-run, however, he said that the consumer expenditure and savings would continue to be tepid, keeping the demand sluggish.

The RBI Governor’s decision was primarily based on an increased inflation reading of 5.39 per cent in April as against 4.83 per cent in March.

Governor Raghuram Rajan appears keen on seeing the effect of the monsoon before taking a call.

Perhaps, he is also willing to await the decision of the Federal Open Market Committee (FOMC) in the U.S. before going in for a further easing.

High rate

The overall high interest rate in India supports savers and investors in debt instruments. However, “corporate earnings and, hence, equity market has been negatively affected by the high interest cost borne by the corporate sector.

Imagine an Indian manufacturer, who pays over 10 per cent and has to compete with a global manufacturer whose capital cost is 7 to 8 per cent lower,” according to Samir Lodha, Managing Director, QuantArt Market Solutions Pvt. Ltd., a currency risk management firm.

Rupee’s low

During February this year, the rupee touched its recent low level at 68.70 a dollar. Since then, it has stabilised significantly at around 66.70 levels.

“During the second-half of calendar 2016, the rupee can be expected to depreciate by 3 to 5 per cent more because of global factors driving U.S. dollar strength”, Mr. Lodha added.

Ironically, Mr. Lodha said, the U.S. Fed’s policy was impacting the Indian markets more than local monetary policy.

Expectations on whether the Fed would hike rates or not moved equity as well as foreign exchange markets, he added.

According to him, the second-half of 2016 is likely to see global markets volatility triggered either by a Fed rate hike or concerns around global growth.

“Such volatility will impact the Indian foreign exchange market as well as equity markets adversely,” he added.

Global effects

While India is doing well on macro-economic aspects (such as high growth rate of 7.9 per cent, moderate inflation of 5.39 per cent, current account surplus, controlled fiscal deficit and large forex reserve of $ 360 billion), the country is not insulated from global shocks.

Still, foreign capital sways the market in India in tandem with global markets.

India’s trade deficit has come down significantly from around $ 10-12 billion a month to $ 5-6 billion a month thanks to lower crude oil price.


Remittances into India as well as software exports have decreased. However, India is experiencing a current account surplus.

India was largest receiver of remittances in the world at around $ 70 billion in 2015, though data for April 2016 has been a shocker with a 90 per cent drop in remittances.


Slowdown in the Middle East, no doubt, puts a strain on India’s remittances. Mr. Lodha said, “We expect a broad steady flow will be maintained in the future.”

In a world which is leveraged extensively through debt, investors would be prepared to move to cash whenever initial signs of panic hit them.