Even though Dalal Street is eagerly awaiting an interest rate cut after the weak April industry output, Chetan Ahya, Managing Director, Morgan Stanley has warned that premature easing by RBI may aggravate the economy’s current problems.
Monetary policy will be less effective in
dealing with the effects of a stagflation-type environment. For an effective reduction in the cost of capital, the efficient cycle would be reduction in public expenditure (fiscal deficit) which helps to reduce consumption; increase savings and thus lowers the current account deficit and inflation pressures, Ahya said in a report. However, he cautions that the government’s current policy stance will keep the fiscal deficit high and therefore the current account deficit and inflation will remain a challenge making it difficult to lower the short-term cost of capital meaningfully.
The brokerage’s growth forecast is in the range of 6 percent till June 2013 and it’s going to be tough for them to have an effective reduction of cost of capital even if RBI cuts policy rates because of the current stagflation-like environment. Explaining the ‘bad growth mix’, bank’s Ahya said the much-talked about consumption story is being supported by a high fiscal deficit, while elevated rates have resulted in a decline in private investments, which is “not sustainable”.
In an interview with CNBC-TV18, Ahya explained that if the RBI cuts the cash reserve ratio and injects a lot of liquidity through Open market operations there will be a transmission into lower borrowing costs in the system. “It would not be sustainable because the gap between credit growth and deposit growth will probably widen if we try to bring down deposit rate too much,” he said.
RBI move in April is yet to result in the real cost of borrowings coming down due to a variety of reasons and pointed out that a reduction in cost of capital will alone spur growth.
He argued that the high growth phase between 2003 and 2007, which saw the economy growing at over 9 per cent annually, was made possible only because it was private investment-led, unlike the consumption-led growth which the country is relying on right now. (curtsey : first post)
Rupesh Yatesh Dalal
Head Research Department
Head Research Department
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