India’s Annual Monetary Policy 2011 – Inflation Is Expected To Remain High Amid Robust Economic Growth.

The thirst of robust economic expansion and higher commodity prices will technically push inflation on the upside and interest rate in India is expected to remain high for the next couple of fiscal years as the RBI seeming to keep interest rates on the higher side to maintain the cost of credit exorbitant to lessen the demand.


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It was the confrontational step of the Reserve Bank of India by revising another 50 bps in its policy rates to address the wild price rise situation in order to eliminate the risk of higher inflation and to persuade the Indian economy to grow fast but sustainably. VMW has analyzed the inflation problem from the household’s kitchen to the corporate decision maker and found that the food prices are not rising as fast as the non-food articles do, due to increase in international commodity prices. Food prices in March rose by 9.47 per cent while the prices of non-food articles rose by 25.88 per cent largely inflated by expensive crude oil and other important imported commodity products. So far, the effect of RBI’s rate tightening and expensive commodity prices – rallied on the economic euphoria – can be seen on the Capital Goods sector of India. India’s IIP index has been fluctuating, and the capital goods, index in particular, has performed deplorably (see figure below) due to higher cost of credit, tolling in the company’s income statement in terms of higher interest payments. Construction, Energy, Real Estate, Diversified and Infrastructure companies have piled up billions of dollars in terms of debt to function their operations and to execute their awarded projects.


The important wings of the Indian government and the Reserve Bank of India are expecting the inflation around 6 per cent by the end of the fiscal year 2012. However, the VMW’s estimates are bucking the government and RBI’s estimates – expecting the inflation to remain above 6 percent and even in a double digit by the end of this year (up to 11 percent). The only fundamental cause is the India’s hunger of economic expansion at a faster pace, and the same would not pull down the inflation to lower levels, since it will dramatically push the demand in the economy for pricey imported commodity. Moreover, the US Federal Reserves’ monetary expansion program, known by Quantitative Easing or QE2 is scheduled to end by Jun, 2011 and, perhaps, it will not reduce the impact of higher inflation in the economy right away and high supply of a dollar could depreciate it against the other major currencies, which will push the international commodity prices. The expensive imports will prevail upon the higher current account deficit until the export figures too remain blunt. Henceforth, the Current Account Deficit remains a prime concern for the economy. Although, RBI is not considering it as a major threat but the VMW is deliberating the same, and the prime predicament could be the lower portfolio investments since Foreign Institutional Investors’ flows (FII) are the immediate source of financing the Current Account Deficit and Foreign Direct Investments are not as easy as the FII flows are due to scores of roadblocks to the investments and instability in national politics and India’s foreign policy.


Inflation always Remained High in India and Now Needs Government Intervention Plus Tighter Monetary Policy from RBI’s Side. 

Now, in our research lab, we have analyzed the inflation problem. Look at the GDP Deflator and the WPI Inflation rate – how these trend lines have emerged over the past six fiscal years. GDP deflator is one of the other important tools to measure inflation, and it show, the inflation problem was relentlessly haunting the Indian economy. The most significant discovery is, the RBI loosened the policy rates during FY08, when India faced the condition of deflation due to change in the base year and was not reflecting the correct picture. However, GDP deflator remained at the alarming levels. At the same time, in FY09, RBI has raised the interest rates to prevent India to be a victim of the global financial crisis.


Here, we are not suggesting the RBI to track the GDP deflator, but to align its monetary policy to fix the “structured inflation problem”, caused by huge government borrowings, and at the same time, to make the economic growth sustainable and to refrain from the economic overheating. Plus to this, there is an urgent need of government intervention in terms of policies to overhaul the distribution of agricultural produce, to check the government borrowings and bringing down the fiscal deficit, which is now estimated at 5.6 percent until Feb, 2011 and 5.8 percent for FY2011. This will also subdue the prices.



Future of the Interest Rates in India

Rise in crude oil prices and other imported commodity price holes the Indian Economy up. It is one of the biggest risks to India since the country is not completely reliant on its own energy output and imports more than 70 percent of crude oil from GCC countries and other OPEC members. It’s expected that the global economic recovery would not stall but the pace will come down most importantly when the United States has stepped up its efforts to bring down the fiscal deficit to 4.1 percent by 2014. Nevertheless, the real economic output could remain under pressure due to the effect of increasing government debt. Since, we have focused on the final output (GDP) and it shows the prices of final produce in a particular financial year are increasing by more than 7.0 percent, whereas the WPI inflation is fluctuating throughout the discussed fiscal years. Provided herein is India’s stock of money or M3 for the last three fiscal years, which reverberates above 20 per cent. However, it is now falling significantly back to 15 per cent, and it shows the RBI’s action in policy rate is working, which means the monetary policy has a certain effect on the core inflation problem and would make an impact on the demand side but it is not sustainable as the government’s borrowing plans are on track.





Lower money supply has side effects too as it will increase the cost of credit further, and it will reduce the access to credit. Moreover, the stock markets could not function properly in this environment since the economic activity declines, which will eventually reduce the value of people’s retirement savings. However, the RBI has only one choice – tight monetary policy to tame inflation by giving up the India’s ambitions of double digit economic growth.


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RBI’s Third Quarter Monetary Policy. CRR Raised By 75 Bps.

India’s Central Bank, Reserve Bank of India (RBI) announced its Monetary Policy on Fri, Jan 29, 2010 and decided to raise CRR by 75 bps to 5.75%.

As expected, Central bank, Reserve Bank of India has raised Cash Reserve Ratio (CRR) by 75 bps to 5.75% and keeps its policy rates unchanged as per the expectations of VMW, however the hike in CRR is well above, what we had anticipated. While the global economy is stabilizing, the growth outlook has been revised. Economies have rebounded steadly after the significant government intervention. Over the past two years, RBI has reduced the policy rates and CRR in response to the economic crisis to infuse the sufficient amount of liquidity into the market to emerge from the dried liquidity situation and to provide the ample credit facility to the economy to impede the greater risk of economic trouble for the second fastest growing economy in the world. The general trend of CRR (shown below), shows, how the central bank has responded to the economic trouble. During the reign of YV Reddy, CRR jumped to 9 per cent in Aug 2008 just before the bankruptcy of Lehman Brothers to absorb the additional liquidity in order to prevent the Indian companies (banks & companies) to invest outside into the risky assets.


After few days, Duvvuri Subbarao has taken over the charge of RBI and he decided to reduce interest rates by more than 400 bps, when the financial crisis was at peak. Overall, the RBI has predominantly managed the situation mightily and helped the Indian companies to grow even in a gloomy economic period to a certain extent. Now this time, RBI raised the CRR as the Inflation rate is again at the alarming levels. India’s spiralling money supply over the past few months has grew by more than 22 per cent which is again the another matter of concern, which the RBI is taking it seriously to contain the the rise in prices. Rise in CRR would not likely affect the cost of borrowing as the banks are sitting on ample liquidity and shifting to the demand deposits to reduce their cost. Bank’s CASA , Time Deposit ratio has been shifted very aggresively post economic recession to reduce their cost. However, over the next few quarters, RBI may hike the Repo rate and Reverse Repo rate if the inflationary pressure continues.

RBI Responding To The Economic Downturn, Cut Repo Rate And Reverse Repo Rate.

Day after day, we are witnessing the bad news coming from across the world. In the Year 2009, day by day, the condition of the global economy is deteriorating as the financial crisis has spilled over from a single continent to the across the globe. The effect of the global downturn can be felt in India too to a certain extent, perhaps the Indian authorities are responding on a timely basis to weather this horrific economic catastrophe. In response to that, India’s central bank – Reserve Bank of India (RBI) has further eases the monetary policy on Wed, Mar 4, 2009 by slashing policy rates by 50 bps with immediate effect.

RBI has reduced the Repo rate by 50 bps to 5.0% from 5.5% while there is also a reduction of 50 bps on reverse repo front by 50 bps to 3.5% from 4.0%. However the CRR remained untouched. According to the RBI, there is no need to reduce the Cash Reserve ratio as of now, but will be considered if needed. Since the Oct, 2008 RBI has reduced the policy rates, CRR and SLR by number of times in order to maintain the flexibility in the banking system and the functioning of the Financial Markets in an orderly manner.

VMW Definitions:

  • Repo Rate: is a rate at which, RBI repurchases Govt Securities from the commercial banks to expand the money supply in exchange of cash.
  • Reverse Repo Rate: Vice versa of Repo rate means to sell Gov’t bonds in exchange of cash.
  • CRR: is a Cash Reserve Ratio. Banks kept some portion of their deposits with the RBI at a prescribed reserve rate.
  • SLR: is the Statutory Liquidity Ratio at which banks need to kept short term securities such as Cash, Gov’t Securities, Precious Metals like Gold and Silver and other short term securities.
  • BPS: is Basis Points which should be defined by One Hundredth of a one percentage point (1/100th of 1%). It is commonly used in expressing differences of interest rates.

If you need further clarification on these Finance terms, send an email at