Increased Interest Rates and Inflation – Good for some, bad for many?


While Idea has been spicing up the Mobile market in India, and while the spice in the Indian Consumers food is missing courtesy increased commodity prices, the Reserve bank of India has hit out further by increasing the repo rates (the rate at which the RBI lends out money to the other banks) and the Cash Reserve ratio (CRR, the minimum amount of cash stocks the banks must maintain). The logic RBI gives is that it is going to tame the liquidity in the market by squeezing the excess cash floating in the market.

But is it what we really require? The RBI seems to have a notion that the current crisis is demand pull inflation where too much money chases too few goods. Rather the case right now is that of Cost-Pull inflation wherein the companies have to increase cost of commodities as a result of increased input costs like hike in oil prices, raw materials, basic metals and increased tax rates and import duties. This is very similar to what we have been observing off-late where the prices of inputs which go into manufacturing of these commodities have grown over the time. While the appreciating rupee saved us from the wrath last year, this fiscal the rupee has depreciated as well.

The policy of the RBI is going to lead to stagflation (high unemployment and economic slowdown).

1.   The current food crisis led to government completely banning export of major food commodities and completely decreasing the tariffs on imports. This would surely hurt the revenues of the govt. and also the overall economic growth to some extent.

2.   Moreover the RBI on increasing the rates has resulted in greater difficulty for the corporate sector to get loans from the govt. in terms of debts, moreover the markets are difficult to get the cash flowing to these corporations due to the increased alienation of the market by the investors due to inflation (as seen by the continued downward trend of the markets). This will only lead to companies shunning economic expansion and further slowing down the economic growth of the country.

3.   The increased interest rates are going to hit the general public by and large. Due to increase in the repo rates by the central bank (RBI), the banks are going to increase the primary lending rates which will be generally ranging from loans for homes, automobiles and even study loans. The consumers taking loans at this time should take a loan on floating rates so that when this inflation is finally tame and the rates are finally decreased they still don’t keep paying the same as they will be now. Moreover consumers already facing the music due to increased rates and EMI’s should try to increase the duration of payment in years to bring down the EMI.

4.   The biggest sector that is going to be hit by this interest rates hike is the Real Estate sector which is so susceptible to the market interest rates. As the customers are going to stay away from taking loans and buying the property the sector will generally slowdown. Moreover the big corporations are just going to wait before rolling out any expansion plans, so cutting down on infrastructure and further slowing down this sector. However because this is going to drive property prices slightly lower in most markets, it is not going to be a particularly bad idea to buy properties right now, probably on floating rates.

5.   Another sector which is particularly going to suffer is Automobile sector. Already the input costs like steel have gone up, the oil prices have gone up keeping consumers away from the roads and now the increased rates will surely slow down the sales, and most of the CEO’s won’t be able to achieve their targets.

6.   However as the lending rates will go up, so will the rates at which banks borrow from individuals and companies. So the particular debt-free cash rich companies are going to gain. Moreover this is generally going to make the market less attractive. Moreover as Markets are meant to give you better returns than the banks especially in terms of maintain the purchasing power of your money over the years. Moreover more and more people are leaving the markets; FII’s as well who are anticipating a general economic slowdown. However this should be seen as the best time to jump-in the stock market.

7.   Moreover the cap on FDI will generally keep away the investors from investing in the country due to a nominal appreciation only, so the cap must be increased. We observed that FDI cap in Real Estate in India has gone up leading to a lot of infrastructral investment and economic activity.

8.   At the same time the depreciation of the rupee has to be controlled in the wake of increased international oil process. This will further help in taming the inflation. Some export oriented sectors will be affected but then the present situation demands a more balanced approach.

As the lending rates increase and the liquidity crunch prevails, will generally tend to economic slowdown. However the RBI and the govt. must try to find out better ways to balance the rising inflation and economic growth of the country.

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