Quantitative easing

An unconventional monetary policy in which a central bank purchases government securities or other
securities from the market in order to lower interest rates and increase the money supply. Quantitative
easing increases the money supply by flooding financial institutions with capital in an effort to promote
increased lending and liquidity. Quantitative easing is considered when short-term interest rates are at
or approaching zero, and does not involve the printing of new banknotes.
Quantitative easing (QE) is an unconventional monetary policy used by central banks to
stimulate the economy when standard monetary policy has become ineffective.
[1][2][3]
A central
bank implements quantitative easing by buying specified amounts of financial assets from
commercial banks and other private institutions, thus increasing the monetary base and lowering
the yield on those financial assets.
[4]
This is distinguished from the more usual policy of buying
or selling short term government bonds in order to keep interbank interest rates at a specified
target value.
[5][6][7][8]

Expansionary monetary policy to stimulate the economy typically involves the central bank
buying short-term government bonds in order to lower short-term market interest rates.
[9][10][11][12]

However, when short-term interest rates have reached or are close to reaching zero, this method
can no longer work.
[13]
Quantitative easing may then be used by monetary authorities to further
stimulate the economy by purchasing assets of longer maturity than short-term government
bonds, and thereby lowering longer-term interest rates further out on the yield curve.
[14][15]

Quantitative easing raises the prices of the financial assets bought, which lowers their yield.
[16]

Quantitative easing can be used to help ensure that inflation does not fall below target.
[8]
Risks
include the policy being more effective than intended in acting against deflation (leading to
higher inflation in the longer term, due to increased money supply),
[17]
or not being effective
enough if banks do not lend out the additional reserves.
[18]
According to the IMF and various
other economists, quantitative easing undertaken since the global financial crisis of 200708 has
mitigated some of the adverse effects of the crisis.
The goal of this policy is to increase the money supply rather than to decrease the interest rate, which
cannot be decreased further.
[23]
This is often considered a last resort to stimulate the economy.

Quantitative Easing: What it means
to you


The governor of US Federal Reserve Ben Bernanke and US treasury secretary Tim
Geithner visited Reserve Bank of India office in Mumbai and met with governor D
Subbarao. For the first time in the history, a US Federal Reserve chairman visited India and
met with RBI. Financial markets around the world watch every move that Ben Bernanke
makes. Trillions of dollars move from one market to another if US Federal Reserve cuts or
raises interest rates.

The idea of making this trip was to explain the US monetary policy of quantitative easing or
'QE' to India.

Here are few pointers that could help you comprehend why this matters to India's stock markets
and businesses:
What is it:
Quantitative easing means buying of assets by a nation's central bank in order to inject money
into the financial system. The US Federal Reserve has used this method to provide easy money
to banks so that they can lend to businesses at cheap interest rates for expansion and thus
stimulate growth. The move is expected to create more jobs in America. The priority for US
central bank is to stimulate growth in their country. The intention of quantitative easing is not to
affect the world. However, since financial markets are inter-connected, any step by US Federal
Reserve to put easy money in markets influences the world including Indian markets.

What does it do:
Quantitative easing cuts borrowing rate. The idea is to discourage savings by individuals and
businesses. The US economic growth is dependent on spending by individuals and businesses
for consumption of goods and services. With interest rates staying at near zero per cent,
individuals and businesses are forced to invest in risky assets like stocks, bonds or debt
instruments or commodities to earn a return on savings. This floods money into global investment
institutions.

Why world bothers:
Global financial institutions drive money that flows into various markets around the world. A loose
monetary policy means global banks are flooded with cash that they have to deploy in productive
assets. This results in more money flowing assets like debt, equity, commodity among others.
There is a concern that the easy money from US could inflate commodity prices. However, since
the launch of the third quantitative easing by the US Federal Reserve, commodities like oil and
metals have remained flat.

Impact on India's businesses:
Easy money overseas means that Indian companies could resort to borrowing more overseas.
According to the latest RBI monthly data for August 2012, Indian companies sought permission to
borrow to the tune of $ 2.4bn. Borrowing overseas is good if interest rates are low but with the
Indian rupee remaining volatile, companies could get hurt due to currency losses. If the rupee
remains stable, the overall borrowing cost of companies could fall. However, if it falls further,
companies may have to pay more.

India's stock market:
Foreign institutional investors have injected close to $ 18bn in Indian equity markets. The BSE
Sensex has gained over 15 per cent in 2012 thanks to this money from FIIs. This is despite
India's government taking steps to annoy foreign investors by introducing general anti-avoidance
rules in the budget. Market experts say that this is because FIIs have limited investment option for
investment in the world and India is among few economies that has witnessed any growth.
Experts say that many bought Indian equities in anticipation of the quantitative easing announced
in September by US. The quantitative easing will ensure that FIIs would not pull out money so
quickly from India.

How Indian economy, markets can counter
QE tapering impact
The Nifty is one of the worst performing benchmarks in the global markets today after the US
Federal Reserve announced tapering of quantitative easing from January.
There are concerns that the tapering would result in depreciation in the Indian currency and
lesser FIIs inflow, the main driver of rally in the Indian equities.
The US Federal Reserve has cut monthly quantitative easing by $10 billion to $75 billion from
January and gave hints that the interest rates will be hiked in 2015.
Analysts say the US Federal Reserve's move is dovish and it won't have a big impact on Indian
markets.
"What US Fed has announced is a very dovish stand. We can call it is a mild tapering and I do
not think it will have any significant negative impact on any markets definitely not on the Indian
markets. Tapering had to happen and this is probably the best course of action as far as tapering
is concerned. At any point of time I do not think we should assume that US Fed will do
something which will lead to a major meltdown in the global markets," said Sudip
Bandyopadhyay, President, Destimoney Securities in an interview to ET Now.
According to Bandyopadhyay, if the macro economic situation improves in India, liquidity will
not be an issue. If that happens, India will continue to attract liquidity.
"We had better than expected numbers in Q2. We are expecting similar set of numbers in Q3 and
provided those numbers are encouraging, Indian markets will take positive cue," he added.
The market has taken the QE tapering announcement in its stride, says Dhananjay Sinha, Co-
Head, Institutional Research-Economist & Strategist, Emkay Global Financial.
"If you look at the global markets, they actually went up after a small downside. Earlier the Fed
was actually dithering with respect to tapering and so a lot of reasoning has happened ahead of
the latest announcement and there seems to be a relief rally after the event is out of the way," he
said.
"My sense is that as the event gets absorbed by the market, it is possible that the global excess
liquidity will be lesser and hence, that will impact the market. However, the tapering itself will
reinforce the strength in the US economy, which means that the sectors dependent on the US
economy will actually do well. Therefore, companies which have larger exposure to exports can
actually do well and get re-rated," he added.
Analysts are of the view that markets are better prepared for tapering than in May and tapering
effect will be muted.
"I do not think, the taper is such a bad news as it was when it was first talked off on May 22nd.
Clearly, the market is a lot better prepared. We have had very successful FCNR (B) scheme
bringing in dollar. We have had FIIs reduce their positions dramatically so there is very little hot
money to go out right now. In general, current account deficit, export numbers are looking a lot
better. So to that extent the market is a lot better prepared which is why the reaction in the
markets across all emerging markets and of course for India seems a lot more muted then it was
in May or June," said Ananth Narayan, Co-Head of Wholesale Banking, South Asia, Standard
Chartered Bank.
According to the Finance Minister P Chidambaram the QE tapering announcement has not
come as a surprise. He said that India is well prepared to deal with QE taper and markets had
already factored in a mild taper.
The Indian market is likely to consolidate for the next three to six months, says Bandyopadhyay.
"The political uncertainty which was plaguing the Indian markets is to an extent put in the back
burner. There will be re-emergence of these factors some time may be by end March-April but as
things stand for the next two months we are looking at a steady growth of the Indian markets
based on sheer fundamentals," he added.

Quantitative easing: Impact on emerging and developing economies
Shyam Saran, a former Indian Foreign Secretary, warns that the financial policy of
'quantitative easing' (QE) adopted by the world's most powerful economies - the United
States, the European Union, the United Kingdom and Japan, otherwise known as the G4
- is having adverse effects in the developing world due to resulting expansionary and
distortionary capital outflows.

THE global economy is awash with successive waves of liquidity generated over the past
few years by the four most advanced economies, viz., the United States, the European
Union, Japan and the United Kingdom, known as the G4. This liquidity has taken the
form of 'quantitative easing' (QE).
When zero rates of interest have failed to stimulate their economies, these countries
have resorted to large-scale purchases of assets, such as corporate bonds or mortgage-
backed securities, by their central banks to pump more money into the banking system.
The aim is to extend credit to business and industry and encourage consumption.
In the immediate aftermath of the global financial and economic crisis in 2008, when
there was a danger of financial collapse, both advanced as well as emerging economies
adopted stimulus packages to revive demand, maintain trade flows and avoid large-scale
unemployment. During the crisis phase of 2008-09, QE played an important role in
crisis management, helping advanced and emerging economies alike.
However, while emerging economies have weathered the crisis and seen a revival of
growth, the G4 continue to experience economic stagnation, depressed markets and
large-scale unemployment.
Their response has been to persist with even larger doses of QE as a means of propping
up demand, encouraging banks to expand and boosting stock valuations.
Before the crisis, the US held $700 to $800 billion of Treasury notes. The current level
is $2.054 trillion. In the latest round, QE-3, the US Federal Reserve is committed to the
purchase of $40 billion of mortgage-backed securities per month as long as
unemployment remains above 6.5%.
The European Central Bank (ECB) has pumped 489 billion euros of liquidity into the
euro zone since the crisis, while in the United Kingdom QE has reached the level of 375
billion pounds.
Most recently, the Bank of Japan has decided to pump $1.4 trillion in the next two years
into its economy, aiming at a 2% inflation rate by doubling the money supply.
The assets of the G4 central banks have expanded from a figure of 11-12% of their gross
domestic product (GDP)to the current unprecedented level of 23%. These assets were
$3.5 trillion in 2007 before the crisis. They are now $9 trillion and rising. This is the
scale of liquidity expansion we are dealing with.
Capital surge
Since interest rates in the G4 remain at zero and their economies remain stagnant, it is
inevitable that there will be significant capital outflows to emerging and other
developing economies, in quest of higher risk-adjusted returns.
According to one estimate, about 40% of the increase in the US monetary base in the
QE-1 phase leaked out in the form of increased gross capital outflows, while in the QE-2
phase, the figure may have been about one-third.
This massive and continuing surge of capital outflows to emerging and other developing
economies is having a major impact. Corporations which have a sound credit rating are
taking on more debt and increasing their foreign exchange exposure, attracted by low
borrowing costs. Their vulnerability to future interest rate changes in the developed
world and exchange rate volatility will increase.
Such inflows put upward pressure on exchange rates, stimulate credit expansion, and
cause inflationary pressures, which pose a major challenge to policy-makers in the
developing world.
Most of the capital inflows are in the nature of portfolio investments, which are prone to
sudden and volatile movement and put emerging economies at greater risk. The
volatility one has witnessed in the Indian stock market is a case in point. In general, we
may conclude that the overall impact of these capital flows is expansionary and
distortionary.
Global impact
There has been considerable criticism of the G4's unconventional monetary policies
from the emerging economies, including the BRICS (Brazil, Russia, India, China and
South Africa).
The magnitude of QE has had unintended consequences beyond the borders of the G4,
especially because their currencies are not only fully convertible but, together, constitute
the pillars of the global financial system.
The US dollar is the world's leading reserve currency, and the euro, the British pound
and the Japanese yen together with the dollar constitute the basket of currencies the
International Monetary Fund (IMF) uses to value its Special Drawing Rights. Thus, the
nature of the G4 currencies and their significant role in the global financial market
ensures that QE undertaken by the G4 has a global impact on economies across our
globalised and interconnected world.
It is necessary, therefore, for the G4 to act with great responsibility and to work together
with the emerging economies to minimise the adverse effects of their QE policies. It
would be particularly important to forge a consensus on how to handle the potential
financial turmoil and disruption that may afflict developing economies once the QE is
sought to be retired and interest rates once again become positive in the G4. A sudden
and large-scale reversal of capital flows is a likely scenario that would need to be
anticipated and managed.
The Asian financial crisis of 1997-98 was, in part, triggered by an earlier version of QE
pursued by Japan in the aftermath of the bursting of its property and asset bubble in the
early1990s. Then, too, the large inflow of low-cost yen loans led to asset price bubbles,
inflationary pressures and currency instability in the Asian economies. They paid a
heavy price in the bargain.
A larger, more pervasive crisis may await the emerging and developing economies
unless there is a much more coordinated and careful handling of the risks that are
already building up. The G20 major economies grouping should have this issue at the
top of its agenda. - IPS
What effect has US Quantitative Easing On Indian Economy?? What is present scenario ??
What link and role it has in recent global developing country slowdown?


Basically,investors (FIIs,QFIs etc) who had access to this cheap money (courtesy>>QE) will not
have this privilege.Also as USA's market recovers these guys will prefer investing in those
markets(Read>>Outflow of Dollar from Indian Markets)


Your explanation reminded me of Assertion-Reason questions in CSAT. The two statements,
although correct if interpreted independently, don't correctly explain why US easing would affect
Indian Economy.

Basically,investors (FI I s,QFI s etc) who had access to this cheap money (courtesy>>QE) will
not have this privilege
Investors invest, they don't try to access or look for cheap money. On the contrary, they look to
invest at a place which can provide them highest returns. The "cheap money" term has gained
popularity in the background of 2008 recessions when Federal Bank of US started lending on
low or even 0% interest rates to encourage growth (similar to how RBI cuts bank rates to inject
liquidity).

Also as USA's market recovers these guys will prefer investing in those
markets(Read>>Outflow of Dollar from I ndian Markets)
Investors are not running merely because US markets seem to recover. They go back because
Fed is now looking to cease the "cheap money" policy and increase lending rates which means
they'll get good returns from fed if they invest money there. Indian rates are competitive as well
investors would obviously invest in most stable market/currency economy, if both offer good
rates.

Our PM is going to raise this issue in coming G20 - "How monetary policy of developed
countries affect economies of developing countries".

Basic point is we need someone to put onus upon. When we faced low growth we blamed US
recession and low demands from US & Euro. Now currency is going down, we are pointing to
US recovery.
Thanked by 1VishalJ


VishalJ September 2013
Siddharth said:
VishalJ said:
aspirant21 said:
What effect has US Quantitative Easing On Indian Economy?? What is present scenario ?? What
link and role it has in recent global developing country slowdown?


Basically,investors (FIIs,QFIs etc) who had access to this cheap money (courtesy>>QE) will not
have this privilege.Also as USA's market recovers these guys will prefer investing in those
markets(Read>>Outflow of Dollar from Indian Markets)


Your explanation reminded me of Assertion-Reason questions in CSAT. The two statements,
although correct if interpreted independently, don't correctly explain why US easing would affect
Indian Economy.

Basically,investors (FI I s,QFI s etc) who had access to this cheap money (courtesy>>QE) will
not have this privilege
Investors invest, they don't try to access or look for cheap money. On the contrary, they look to
invest at a place which can provide them highest returns. The "cheap money" term has gained
popularity in the background of 2008 recessions when Federal Bank of US started lending on
low or even 0% interest rates to encourage growth (similar to how RBI cuts bank rates to inject
liquidity).

Also as USA's market recovers these guys will prefer investing in those
markets(Read>>Outflow of Dollar from I ndian Markets)
Investors are not running merely because US markets seem to recover. They go back because
Fed is now looking to cease the "cheap money" policy and increase lending rates which means
they'll get good returns from fed if they invest money there. Indian rates are competitive as well
investors would obviously invest in most stable market/currency economy, if both offer good
rates.

Our PM is going to raise this issue in coming G20 - "How monetary policy of developed
countries affect economies of developing countries".

Basic point is we need someone to put onus upon. When we faced low growth we blamed US
recession and low demands from US & Euro. Now currency is going down, we are pointing to
US recovery.

Indian general election, 2014

The general election will be held in nine phases, the longest election in the country's history,
from 7 April to 12 May 2014 to constitute the 16th Lok Sabha in India. Voting will take place in
all 543 parliamentary constituencies of India to elect Members of Parliament in the Lok Sabha.
[1]

The result of this election will be declared on 16 May 14, before the 15th Lok Sabha completes
its constitutional mandate on 31 May 2014.
[2]

According to the Election Commission of India, the electoral strength in 2014 is 81.45 crores
(814.5 million), the largest in the world.
[3]
There is an increase of 10 crores (100 million) newly
eligible voters.
[4]
This also will be the longest and the costliest general election in the history of
the country with the Election Commission of India estimating that the election will cost the
exchequer Rs 3,500 crores, excluding the expenses incurred for security and individual political
parties.
[5]
Parties are expected to spend 30,500 crores (about US$5 billion) in the election,
according to the Centre for Media Studies. This is three time what was spend in the previous
election and is the world's second highest after the US$7 billion spent on the 2012 U.S.
election.
[6]

Following are the highlights of RBI's third quarter review of monetary policy:

*Key lending rates hiked by 0.25 per cent to 8 per cent

*Cash reserve ratio kept unchanged at 4 per cent

*Marginal Standing Facility (MSF) rate stands at 9 per cent

*GDP growth to be less than 5 pc in current fiscal

*Growth to improve to 5.5 pc in 2014-15

*Current Account Deficit to be below 2.5 per cent this fiscal

*March-end inflation could exceed 8 per cent

*Rate hike will set economy securely on disinflationary path

*Growth likely to lose momentum in Q3 of 2013-14

*Slowdown in economy getting increasingly worrisome

*Inflation is a tax that is grossly inequitable, falling hardest on the very poor

*Fiscal and monetary authorities should continue to work for macroeconomic stabilisation

*Henceforth, policy review to take place every two months

*Next review on April 1
Third Quarter Review of Monetary Policy 2013-14
On the basis of an assessment of the current and evolving macroeconomic situation, it has been decided to:
increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.75 per
cent to 8.0 per cent; and
keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time
liability (NDTL).
Consequently, the reverse repo rate under the LAF stands adjusted at 7.0 per cent, and the marginal standing facility
(MSF) rate and the Bank Rate at 9.0 per cent.
Assessment
2. Since the Mid-Quarter Review of December 2013, the global recovery is gaining traction, led by the
strengthening of the US economy, but it is still uneven and subdued in the Euro area and Japan, and a slowdown in
China seems to be underway. Notwithstanding the boost from stronger external demand, uncertainty continues to
surround the prospects for some emerging economies, with domestic fragilities getting accentuated. Financial
market contagion is a clear potential risk.
3. Domestically, some loss of momentum of growth is likely in Q3 of 2013-14, despite a strong pick-up in rabi
sowing. Industrial activity remains in contractionary mode, mainly on account of manufacturing, which declined for
the second month in succession during Q3. Consumption demand continues to weaken and lacklustre capital goods
production points to stalled investment demand. Fiscal tightening through Q3 and Q4 is likely to exacerbate the
weakness in aggregate demand. Lead indicators of services suggest a subdued outlook, barring some pick-up in
transport and communication activity.
4. While retail inflation measured by the consumer price index (CPI) declined significantly on account of the
anticipated disinflation in vegetable and fruit prices, it remains elevated at close to double digits. Moreover,
inflation excluding food and fuel has also been high, especially in respect of services, indicative of wage pressures
and other second round effects. In terms of the wholesale price index (WPI), headline inflation eased to a four-
month low with the sharp decline in vegetable and fruit prices. Non-food manufactured products (NFMP) inflation,
however, rose in December on an uptick in prices of chemicals, non-metallic minerals and paper products.
Hardening prices of services and key intermediates seen in conjunction with rising bank credit, increase in order
books, pick-up in capacity utilisation and the decline in inventories of raw materials and finished goods in relation
to sales suggests that aggregate demand pressures are still imparting an upside to overall inflation. It is critical to
address these risks to the inflation outlook resolutely in order to stabilise and anchor inflation expectations, even
while recognising the economy is weak and substantial fiscal tightening is likely in Q4.
5. Liquidity conditions were impacted by the mid-December advance tax outflows. Recourse to the MSF rose from
an average of `27 billion during the first half of December to an average of `250 billion in the second half, and the
weighted average call rate moved up to 8.4 per cent from sub-LAF overnight repo rate levels. Although liquidity
eased in the first week of January 2014 due to large redemptions by the Government, it started tightening thereafter
with the build-up of Governments cash balances with the Reserve Bank. In order to normalise liquidity conditions
in the face of these frictional pressures, the Reserve Bank conducted 7-day term repos of `100 billion on January
10, followed by 28-day term repos on January 17 and 21 cumulating to `300 billion, in addition to the normal
liquidity provision of `1.4 trillion under overnight, 7-day and 14-day repos, and export credit refinance taken
together. After assessing that market liquidity would likely remain tight for a while, and keeping in view the need to
accommodate normal credit growth, open market purchase operations of `95 billion were conducted on January 22
in order to provide liquidity of a more permanent nature. The weighted average call rate has eased in response to
these operations. The Reserve Bank is engaged in active management of liquidity to offset frictional and structural
pressures so that there is adequate credit flow to the supply side of the economy.
6. For the period April-December 2013, the trade deficit has shrunk by 25 per cent from its level a year ago, with
merchandise exports increasing on a y-o-y basis for the sixth consecutive month in December, while non-oil
imports have continued to decline. Accordingly, the current account deficit (CAD) for 2013-14 is expected to be
below 2.5 per cent of GDP as compared with 4.8 per cent in 2012-13. The recent resumption of portfolio flows,
both equity and debt, alongside the pick-up in FDI and external commercial borrowings that is underway should
help finance the current account deficit comfortably. Reserves have been rebuilt since September, and oil marketing
companies have been buying foreign exchange in the market to repay the Reserve Bank when their swaps come
due. Despite a significantly more comfortable external position than in the summer of 2013, both fiscal and
monetary authorities need to continue their efforts at macroeconomic stabilisation.
Policy Stance and Rationale
7. In the Mid-Quarter Review on December 18, 2013, the policy decision was to wait for more data before acting.
With the subsequent substantial fall in food prices, especially of vegetables, headline inflation has fallen
significantly. Some of these effects will continue into the next round of data readings. CPI inflation excluding food
and fuel has, however, remained flat and WPI inflation excluding food and fuel has risen.
8. The Dr. Urjit Patel Committee has indicated a glide path for disinflation that sets an objective of below 8 per
cent CPI inflation by January 2015 and below 6 per cent CPI inflation by January 2016. The Reserve Banks
baseline projections set out in the accompanying Review of Macroeconomic and Monetary Developments for Q3 of
2013-14 indicate that over the ensuing 12-month horizon, and with the current policy stance, there are upside risks
to the central forecast of 8 per cent. An increase in the policy rate will not only be consistent with the guidance
given in the Mid-Quarter Review but also will set the economy securely on the recommended disinflationary path.
The extent and direction of further policy steps will be data dependent, though if the disinflationary process evolves
according to this baseline projection, further policy tightening in the near term is not anticipated at this juncture.

9. If policy actions succeed in delivering the desired inflation outcome, real GDP growth can be expected to firm up
from a little below 5 per cent in 2013-14 to a range of 5 to 6 per cent in 2014-15, with risks balanced around the
central estimate of 5.5 per cent. A pick-up in investment in an environment in which external demand continues to
be supportive of export performance could impart an upside to this forecast.
In a surprise move, the Reserve Bank of India (RBI) on Tuesday hiked key policy interest rates by 0.25 per cent to
tame inflation. The move would make home, automobile and other loans costlier and further dampen industrial
growth.
The repo rate, what banks pay when they borrow money from the RBI to meet their short-term requirements, was
increased to 8 per cent from 7.75 per cent per annum.
The reverse repo rate that the RBI pays to commercial banks when they park their surplus short-term funds with the
central bank, has been adjusted to 7 per cent.
In its third quarter review of the monetary policy, the RBI also hiked the marginal standing facility rate by 0.25 per
cent to 9 per cent.
However, the cash reserve ratio (CRR) has been kept unchanged at 4 per cent.
Key takeaways
-CPI inflation remains high
-Upside to risk 8 per cent inflation forecast
-MSF, bank rate adjusted to 9 per cent
-CRR unchanged at 4 per cent
-Slowdown in economy worrisome, says RBI Governor Raghuram Rajan
-FY15 CAD gap seen below 5 per cent of GDP
-Nifty falls 44.80 points
-CPI inflation to be above 9 per cent fo FY14
-Inflation may soften in Q4, upside risks in FY15
-Global recovery gaining traction led by US economy
-Expect FY15 GDP growth at 5.5 per cent
-Monetary policy review to be undertaken in two months cycle, next review on April 1, 2014
-If inflation moves as expected, this may be the last rate hike: C Rangarajan
- Monetary policy reviews to be according to Urijit Committee recommendations
-Expect reserve to swell further going further: Rajan
-Clear sign of recovery yet to emerge, uptick seen in FY15: Rajan
-Hikes in rates consistent with December guidance: Rajan
-Nifty recovers after breaching 6,100 first time since Nov

Reserve Bank of India (RBI) governor Raghuram Rajan has a knack for surprising the financial
markets.
When he had been expected to cut the repurchase rate in each of his first two monetary policy
reviews, in September and October, Rajan did the opposite and raised RBIs key lending rate.
In December, when the markets expected him to raise the rate to douse a surge in inflation, he
left it unchanged. And in his latest policy review on Tuesday, Rajan raised the repo rate again
when 42 of 45 analysts in a Bloomberg poll had predicted status quo.
For the third time in five months, he raised the rate by a quarter of a percentage point, taking it to
8%, in a move that would keep borrowing costs high for companies and consumers for a longer
time than had been foreseen.
With his latest move, the former International Monetary Fund (IMF) chief economist underlined
his credentials as an inflation warrior even if the war he wages on rising prices is at the expense
of a delay in revival of economic growth. Rajan recently described inflation as a destructive
disease that needs to be fought.
It is only by bringing down inflation to a low and stable level that monetary policy can
contribute to reviving consumption and investment in a sustainable way, Rajan, who became
RBIs 23rd governor in September, said on Tuesday. The so-called trade-off between inflation
and growth is a false trade-off in the long run.
RBI expects inflation as measured by the consumer price index (CPI) to top 9% in the three
months to 31 March, and range between 7.5% and 8.5% a year later. Consumer prices rose
9.87% in December, the fastest pace in a basket of 17 Asia-Pacific economies tracked by
Bloomberg.
In the 12 months to March, the central bank expects the economy to grow by a little less than last
years pace of 5%, the slowest in a decade. Growth averaged 4.6% in the first half of the fiscal
year. If the pace of inflation slows, growth can accelerate to between 5% and 6% in the next
fiscal year, according to RBI.


The Confederation of Indian Industry (CII), a lobby group, is surprised by the decision of the
RBI to increase the repo rate, when all indicators suggest that a status quo was in order, said CII
director general Chandrajit Banerjee.
State Bank of India, the countrys largest lender, will take a call on rates after assessing the cost
of funds across different portfolios, said chairperson Arundhati Bhattacharya.
The asset-liability committees of various banks will decide on interest rates, said K.R. Kamath,
chairman of the Indian Banks Association (IBA), the banking industry lobby group and
chairman and managing director of Punjab National Bank.
Its too early for banks to decide on rates and we will see how the markets move and then
react, Kamath said.
The markets largely took the latest increase in the repo rate, at which RBI lends overnight funds
to commercial banks, in their stride as investors bet that it would be the last in the current cycle
of monetary policy tightening.
The rupee rose 0.94% to 62.515 a dollar, the BSE Sensex fell 0.12% to 20,683.51 points and the
yield on the 10-year government bond fell to 8.751% from 8.768%. In the past year, the rupee
has depreciated about 14% against the dollar, making imports more expensive and fuelling
inflation.
The gravest risk to the value of the rupee is from CPI inflation, which remains elevated at close
to double digits despite the anticipated disinflation in vegetable and fruit prices, said Rajan.
Moreover, inflation excluding food and fuel has also been high, especially in respect of
services, indicative of wage pressures and other second-round effects.
He went on: Elevated levels of inflation erode household budgets and constrict the purchasing
power of consumers. This, in turn, discourages investment and weakens growth. High inflation
weakens the rupee. Inflation is also a tax that is grossly inequitable, falling hardest on the very
poor.
Growth-inflation conflict
The latest monetary policy review followed the report of an RBI committee headed by deputy
governor Urjit Patel that said inflation targeting should be made the main objective of the central
bank and called for CPI, rather than the wholesale price index (WPI), to be made the anchor of
monetary policy.
RBIs original mandate has been to ensure price stability while keeping an eye on growth. The
Patel committee set a 4% target for CPI by 2016, within a plus or minus 2% band. For now, RBI
should try and bring down inflation from the current level to 8% over a period not exceeding 12
months, and to 6% over a period not exceeding the next 24 months, it said.
The government, anxious to revive growth, was less than enthused by the report, which the
markets saw as a signal that interest rates would stay elevated for longer than foreseen, given that
the CPI reading is far higher than the WPIs.
We know and we have seen that food inflation cannot be curbed purely through monetary
policy, said Arvind Mayaram, economic affairs secretary, in an interview with ET Now news
channel in Davos, Switzerland. There are other structural issues that need to be addressed if we
are to control inflation.
Finance minister P. Chidambaram said RBI must retain the objective of supporting growth while
fighting inflation.
The government and RBI have been in conflict in the past about the need to balance economic
growth and curb inflation. Growth is as much a challenge as inflation. If the government has to
walk alone to face the challenge of growth, then we will walk alone, Chidambaram said in
October 2012 after RBI, under then governor D. Subbarao, failed to cut rates though he had
spelled out a fiscal consolidation plan.
On Tuesday, Rajan said RBI wouldnt increase rates in the near term if inflation eases further.
In fact, if inflation eases at a pace that is faster than we currently anticipate, and that reduction
is expected to be sustained, the Reserve Bank will have room to become more accommodative,
he said. Rajan conceded that the economic slowdown is getting increasingly worrisome.
Our current assessment is that growth is likely to lose momentum in Q3 of 2013-14, with
industrial activity in contractionary mode, mainly on account of manufacturing, he said. Lead
indicators of services also suggest a subdued outlook, barring some pickup in transport and
communication activity.
To be sure, inflation has eased in recent months, with WPI slowing to 6.16% in December from
7.52% in the previous month and CPI decelerating to 9.87% from 11.16%, causing economists to
predict status quo rather than a rate increase.
It was a surprise decision (to raise the repo rate) because inflation has started coming down.
Probably, their (RBIs) eyes are focused on bringing inflation down to 8% levels. Monetary
policy always shows its results with a lag; hence, the central bank would have wanted to hike
rates now to bring down inflation to that level, said D.K. Joshi, chief economist at rating agency
Crisil Ltd, a subsidiary of Standard and Poors.
Staying vigilant
Still, core inflation, or non-food, non-oil manufacturing inflation, a key indicator of price
movements, rose 2.81% in December from 2.66% in the previous month. And inflation is way
above the comfort zone of the central bank.
Economists say the risk of persistently high inflation still looms as India heads into the general
election, due in April-May, and interest rates will likely stay high.
RBI is aptly concerned about the much too high and sticky core inflation reading. While it
indicated that rates would be on hold near term, we do not believe that this is the end of the
tightening cycle, Leif Eskesen, chief economist for India and South-East Asia, and Prithviraj
Srinivas, economics associate, at HSBC Global Research, wrote in a report. Further tightening
is needed, in our view, to bring core inflation firmly under control.
Goldman Sachs analyst Tushar Poddar said: Given upside risks to inflation from entrenched
household expectations, we think there are risks that the RBI could hike rates further. Our
current forecast is for the repo rate to peak at 8.5%.
RBI has made it clear that its target is inflation, not growth, said Madan Sabnavis, chief
economist at Care Ratings, a credit assessor.
Probably, India will have to live with high interest rates from now on, he added.
RBI said hardening prices of services and key intermediates, rising bank credit, an increase in
order books, a rise in factory capacity utilization and a decline in inventory levels suggested that
demand pressures were still imparting an upside to overall inflation.
It is critical to address these risks to the inflation outlook resolutely in order to stabilize and
anchor inflation expectations, even while recognizing the economy is weak and substantial fiscal
tightening is likely in Q4, it said.
The central bank listed some silver linings in the economy: a robust agricultural performance
after plentiful rainfall and a significant narrowing of the trade deficit as exports rebound. The
current account deficit is estimated at 2.5% of gross domestic product in the current year against
4.8% in the last. Foreign exchange reserves, at around $290 billion, have been rebuilt since
September.
But controlling inflation is RBIs top priority, Rajan said, and the central bank cannot afford to
let its guard down. We are neither hawks nor doves. We are owls, he said. His deputy Patel
added: Vigilant when others are resting.