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Price pains vs Growth pangs

HT looks at the state of play a day after the RBI announced its mid-quarter review at a time when the country is caught between rising prices and sliding growth. Gaurav Choudhury reports.

business Updated: Sep 19, 2012 02:09 IST
Gaurav Choudhury
Gaurav Choudhury
Hindustan Times

What's the latest on the price front?
Latest price data showed that retail inflation measured by the consumer price index (CPI) stood at 10.03% in August, up from 9.86% in the July. Experts expect prices to rise further.

Why are experts saying that prices will rise further?
It is because the government, in a move fraught with political risks, raised diesel prices by R5 a litre - the steepest hike ever - and capped sale of cheaper cooking gas cylinders to six a year for each family.

Why will a diesel price hike raise prices?

High diesel prices will fan inflation by knocking up cost of ferrying goods across locations while family budgets will take a hit with costlier cooking gas.

What prompted the government to raise fuel prices?
Oil companies are selling fuel at much below cost. The government bears a part of this cost handing out cash payouts to state-owned oil companies. The government had last increased diesel prices in June 2011.

Why did the government take such a politically risky step of raising fuel prices?
The government's economic managers, battling to reverse a severe slowdown that has hit jobs and income growth, have preferred to trade short-term price pains for medium-term growth prospects. High subsidies, however, has widened its fiscal deficit - shorthand for the amount of money that it borrows to fund its expenses - limiting its elbow room to spend on investing in infrastructure and development schemes to spin jobs and multiply income.

What has the RBI done?
Caught between rising prices and sliding growth, the Reserve Bank of India (RBI) on Monday maintained a status-quo on key rates, but cut the cash reserve ratio by 0.25% points to 4.5%.

What is CRR?
CRR is the proportion of deposits banks have to park with the central bank.

What does a CRR cut aim to achieve?
A cut in CRR allows banks to unlock funds for lending. According to estimates, the 0.25% point cut in CRR will allow banks an additional Rs. 17,000 crore to lend.

What is repo rate?
It is the rate at which the RBI lends to banks.

How does repo rate influence interest rates that banks charge from customers?
A lower repo reduces banks' borrowing costs goading them to cut interest rates for final home, auto and corporate borrowers.

Does a reduction in CRR reduce borrowing rates for customers?
Maybe in a very indirect way. With more cash in hand to lend following the cut in CRR, banks may not need to woo customers by offering higher interest rates to shore up their deposit base. Some banks may even consider lowering the interest rates they pay to customers on their fixed and savings deposits to cut costs. Lower costs, in turn, could prompt them to reduce their final lending rates

What are policy rates?
The policy rate acts as the guide for final lending rates that banks charge from borrowers. In tight liquidity situations the repo rate acts as the policy rate. In situations of excess liquidity, when banks park money with the RBI from their pool of lendable resources, the reverse repo rate acts the policy rate.

What prompted the RBI to maintain a status quo on interest rates?
High prices essentially shrink household incomes, as middle-class Indians have to spend much more for the same amount of goods. Since the 2009-10 food-price shocks could not be controlled in time, they spread into what economists call "core inflation", or prices of non-food and non-fuel commodities. India's retail prices are already high and costlier fuel will on knock up prices in the coming months. This has dissuaded the RBI to slash interest rates to suppress prices. Currently, high interest rates have made borrowing costlier for firms.

First Published: Sep 18, 2012 22:59 IST