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Name Specialization Roll Number
Akshay Wardhane Operations 37313
Bhavik Makwana Operations 37155
Mandeep Sandhu Operations 37204
Manoj Kankani Operations 37207
Karthik M Operations 37190
Gopi Krisha Madiraju Operations 37174
Pooja Deshpande Operations 37229
Chhavi Chauhan HR 37157
Macroeconomics
Assignment 1
Q1. Why Raghuram Rajan should reduce interest rates?
Acc. to the recent data released India's economic growth slowed to around 5.3% percent in the
three months to September, slipping from 5.7 percent in the previous quarter fuelling the need to
cut interest rates to achieve the level of growth the policy makers of India have been striving for
through introduction of recent pro-growth policies. High rates are stifling India’s growth by limiting
the resources required by the companies to build the high growth rate trajectory necessary to build
our economy and improve the lives
of one-third of the world’s extreme
poor living in India.
This graph shows that the desired policy rate (based on the Taylor rule) had been above RBI’s actual policy rate since 2012. But after retail inflation dropped to a low of 6.46% in September, below the 8% target for January 2015, and closer to January 2016's target of 6%., the desired policy rate has fallen below the repo rate of 8%, as the chart shows. Taylor rule, is a widely used benchmark to quantify the stance of a central banker. Senior RBI
officials have often used Taylor rule estimates to justify monetary policy decisions in their public pronouncements. In the international market The Organisation of Petroleum Exporting Countries (OPEC) decided not
to impose any limits on the amount of crude being pumped despite a 38% crash in prices. This will
further help in easing inflation and its time RBI gives the “fillip” to the economy as the 6% target for
inflation looks well achievable now.
Other major factors that support the decision to cut rates are:
Hikes in minimum support prices for agricultural produce have been modest.
Consumer goods output continued to contract in September, going by the Index of Industrial Production (IIP) numbers. A rate cut will boost consumption and housing demand. Spare capacity will ensure that this does not translate into price increases. Improvement in housing demand will boost construction, which will mean jobs for the masses.
Farm prices have been stable despite a not-so-good monsoon.
Also, it’s unlikely that lower interest rates would cause a destabilising capital flight. During the "taper
scare" of mid-2013, India was running a very high trade deficit. Investors suddenly baulked at
financing it, causing the overvalued rupee to stumble and forcing the RBI to raise interest rates to
stem capital outflows. Since then, though, India's current-account deficit has narrowed remarkably,
and the rupee is no longer overvalued.
The last time the repo rate was cut to 8% was in April 2012, when wholesale price inflation was 7.5%
and Consumer Price Index was at 10.3%. It is much less than those numbers right now. Also, In
March 2002, when it was cut to 8% from 8.5%. Wholesale price inflation in March 2002 was 1.8%,
precisely the same level as it is now. Thus its high time Dr. Rajan reduces interest rates and puts
India on the growth path.
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Desired vs Actual repo rate
Desired policy rate (based on Taylor rule)
Actual policy rate (Repo rate)
Q.2 Why it is important to keep the interest rates high?
Pressure is mounting on Dr. Rajan, who has acquired a reputation as an ‘Inflation Warrior’ since he
took charge as the 23rd governor of the Reserve Bank of India (RBI). Dr. Rajan, given his Chicago
School moorings, was not expected to adopt a conservative approach. But it is exactly what he did; he
raised benchmark interest rates twice within the first two months and raised them yet again in January
2014.
But combating currency speculators and steadying the rupee was just the immediate priority; there
remained the larger problem of quelling inflation and helping the Centre to pursue its growth agenda.
This is where he took the battle against inflation to the next level by targeting CPI rather than WPI.
As the growth impulse returns in the economy, the RBI would then face the renewed threat of a
bouncing back of inflation.
Little would be achieved if the central bank reduces interest rates and
inflation shoots up as demand picks up, forcing RBI to cut interest rates
again. Also, the RBI governor will wait to see whether lower prices are
sustained. He's said before that it's important not to give up on monetary
tightening efforts until the inflation demon has been slain once and for all. It
would be prudent and beneficial for the economy in the long run to hold on
to interest rate for another quarter till inflation numbers are well under
control.
Retail inflation dropped to a low of 6.46% in September, below the
8% target for January 2015, and closer to target for January 2016 as
6%. But, the catch is that once the base effect fades, the measure
is expected to accelerate again in the first quarter of the next
year. In fact, the RBI model forecasts 7% retail inflation by March
2016, which may be revised lower if commodity prices keep falling.
Dr. Rajan substantiates his claims with appropriate data.
Inflation numbers have fallen mainly on account of a high base effect and low fuel and food
prices
Oil price are not in control of Indian government and could go up anytime
To some extent, food inflation is down on account of seasonal factors; the recent poor ‘kharif’
crop output can push up food inflation again.
The impact of the base effect would be reflected more accurately in the next quarter.
It is not just food prices that are persistently high but even those of other items which remain elevated,
and prices across the board have to come down to enable him to reduce
key rates.
Dr. Raghuram Rajan is facing pressure not only from the government,
industries and analysts but also from his colleagues at the central bank
who feel it is time for a rate cut. Four of the seven external members of
the RBI’s Technical Advisory Committee on Monetary Policy wanted a
rate cut at the last policy meet itself. He's been relentless in his bid to
tame prices, making inflation-targeting the main objective of monetary
policy. While this has won him admirers in the international investor
community and elsewhere, growth-hungry companies, believing he is
out of sync with reality.
“There is no point in cutting interest rates to see inflation pick-up again”, said Dr. Rajan.
“Inflation is high not only in food, but also in non-food items and the best solution for the country is to bring it down. Then I can cut interest rate”, said Dr. Rajan.