Should we cheer or not?

The Monetary Policy Committee of the Reserve Bank of India lowered its inflation forecast for the first half of the current financial year to 4.7-5.1%, and to 4.4% in the second half. It also predicted an enhanced growth rate of 7.4% for the GDP for this year, compared to 6.6% last year. Time to celebrate for the bond market and for banks , wrote A Iyer. When interest rate rises bond prices fall, as they are inversely related. If inflation falls there is a possibility of rate cut in the future which will increase prices of bonds. Banks are required to hold a certain percentage of their deposits in gold, cash or government securities, known as Statutory Liquidity Ratio At present it is fixed at 19.5% but a lot of banks are holding more than 30% of their deposits in government securities, because of their safety, in the absence of lending opportunities. Banks have to account for these bonds at market price and not at their buying price, known as mark to market, which means that banks suffer a loss if prices drop. The RBI expects that the prediction of a normal monsoon this year means food prices will not rise as much. However, a lot depends on the government. There was a promise to increase the Minimum Support Price, which is higher than market price, on crops in this year's budget. Farmers borrow at the beginning of the planting season to buy seeds, fertilizers and pesticides, so if crops fail due to drought or flood they are ruined. Curiously, they suffer equally if there is a bumper crop, known as Cobweb Phenomenon. That is because farmers plant crops according to last year's scarcity and end up producing so much that prices crash and there are no buyers. However, if the government keeps prices high artificially, because of elections next year, food inflation may not be comfortable as the RBI expects. Unable to repay their loans farmers commit suicide. Farmers in every state are agitating for their loans to be waived which will add to fiscal deficit. Petrol and diesel prices are at 4 year highs. The price of petrol after refining is Rs 35 per liter. The government adds around Rs 40 in taxes, and is refusing to reduce them to pay for populist spending before elections. High fuel prices will not only add to transport costs for the people but will also put upward pressure on prices because over 60% of freight is carried by road transport. No wonder RBI survey showed that consumer confidence has fallen from December 2017. Lower interest rates are here to stay for the foreseeable future, cheered T Bandopadhyay. Low interest rate is reputed to encourage more borrowing for new projects, increasing job growth leading to prosperity. Not so wrote Prof R Chinchwadkar. A new study has shown that higher GDP growth is directly related to interest rate and low rate does not result in higher growth. Seems like a circle, doesn't it?