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Its All About RBI, Fed and Elections

Monday, February 03, 2014
By Roop Karnani

Roop Karnani is a Senior Journalist, Author and Industry Analyst

Till the new government comes in June, market volatility will be dictated by the RBI and the Fed. This time around RBI gave a negative surprise by increasing the Repo Rate by 25 basis points. Dr. Rajan has decided that CPI would be his benchmark and interest rates would be data dependent with inflation being his key concern. The immediate target is to bring down CPI to sub 8%.

In his con-call Dr. Rajan said that his team has studied the cause of high and sticky inflation in a well thought out analysis. They have clearly spelt out that the main reason which led to high inflation during the last 4 years of UPA2 was the consistent increase of Minimum Support Price (MSP), year after year of food grains and sugarcane. But Dr. Rajan was polite enough to say that policy makers have of late moderated the MSP increase.

Not only did this lead to high prices of food grains (read mainly paddy, wheat and sugarcane), but it also resulted in a change in cropping patterns, with farmers growing less of other essential food items like pulses, dals, vegetables, etc. as farmers who were assured of high prices started switching to wheat, paddy, coarse grains (jowar, bajri in certain pockets) and sugarcane in Maharashtra, UP, Karnataka, etc.

The problem was compounded by the Food Corporation of India, which didn’t have enough storage space like silos which are inexpensive and easy to build. Since many years, food grains were stored by FCI in the open and during the rains they rotted and had to be thrown away. This was further compounded by the APMC Act. In short, it was gross mismanagement, but Dr. Rajan was polite enough not to say so, except that he hoped that the future government would moderate MSP.

The UPA2 think tank in its wisdom, four years ago took a strategic decision to raise MSP, thinking that the transfer of wealth from the Urban rich to farmers which constitute 70% of population, will bring it to power for a third term. But things went horribly wrong. This only benefited the rich farmers, increased inflation, increased fertilizer subsidies and MNREGA which proved a success later, but never reached the targeted poor, throwing fiscal math out of the window. Not to speak of the various scams which brought about policy paralysis. Worse still crude oil prices remained high and oil subsidy shot up and imports of oil and Gold spiraled out of control and created a CAD problem.

The Fed meanwhile decided to end QE3 and first announced it in the mid 2013 which sent currencies into a tizzy in the EM’s which had high CAD. All kudos to P. Chidambaram and Dr. Rajan to control CAD. Seeing the chaos in the currency markets, Bernanke decided to hold QE3 taper, and frantic and targeted efforts of the Fin Min and RBI brought the INR stability. But now India is better prepared to handle QE3 taper. A reduction of 10 bn dollar in Bond Purchases by the Fed is inevitable.

But despite that the actual event has caused nervousness in stock markets around the world. Mark Mobins head of Franklin Templeton (Asia) says, that during the last 4 years, trillions of dollars have been printed by the world’s 3 largest economies namely US, Japan, China. Banks around the globe are flush with too much liquidity. No asset class is safe except equity. Gold is no longer a safe haven. Crude is trending downwards due to US shale gas revolution. And real estate is yet to recover. So equities are bound to inch up, once the markets knee jerk reaction to QE3 taper settles down.

In India markets will watch each RBI and Fed move closely till the election results are declared. Political ups and downs will also cause volatility. So its all about RBI, Fed and elections till June 2014.

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