The Unexpected from the Rockstar Economist Raghuram Rajan
If you are following the daily news it is very unlikely that you have missed the buzz about our new RBI governor Raghuram Rajan. A scholar from IIT Delhi, IIM Ahmedabad and University of Chicago, he was the youngest member of International Monetary Fund and served in Prime Minister’s Economic Advisory Council before taking up the new responsibility. Known as a rockstar economist he was one of the very people who predicted the global financial crisis of 2008.
He took the office at the time of financial instability. With such extraordinary credentials he inspired high hopes amongst the investors in India. In his first press conference as the governor he made it clear to take all necessary steps to ensure economic growth and curb inflation. He also said that some new reforms will not be welcomed but the role of RBI is not to gain Facebook Likes.
Writer Shobhaa De described him as a hotshot honcho who will put sex back into the Sensex in an article in Economic Times.
Within a fortnight, he unexpectedly introduced some monetary reforms to save the falling economy. He increased repo rate, decreased marginal standing facility and Cash Reserve Ratio.
Beyond the financial jargons, here’s what the new reforms mean in a layman’s term.
It is the rate of interest at which commercial banks can borrow money from the RBI. This has been increased to 7.5% from 7.25% to control inflation. This will increase the interest rates for the loan given and hence reduce liquidity in the economy…
Simplification for a Layman:
Previously since the repo rate was low, the banks borrowed more money from the RBI. These banks could afford to give loans to the people at lower interest rate (SBI gave car loans at 9.95% p.a). Now since they have to pay more interest to the RBI for the money they borrow, they were bound to raise the interest on loans given to public (SBI revised car loan to 10.10% p.a). Now, how will this help to control inflation. Before, due to the availability of easy money, more and more people were going after a product (car for example). With the demand decreasing after rise in repo rate, the price of the product also decreases considerably. Sorry if you had plans to buy a car or house and now feel the increase in interest rate drawing you back. Saving the Indian Economy is the first priority.
Marginal Standing Facility
It is the interest rate at which banks can borrow short term during emergency situation which has been decreased from 10.25% to 9.50%. Note that it is different from repo rate in the sense that it is not lent to the people, but used by companies to meet emergency monetary requirements for growth.
Cash Reserve Ratio
It determines the minimum amount of the total money lent that a bank must have. The minimum maintenance was reduced from 99% to 95%.
What does that mean?
Take for example a bank named XYZ which has 1000 crore rupees that it can lend. Note as per previous Cash Reserve Ratio of 4% (40 crore) it had to keep 99% of 40, ie 39.6 crore with the RBI. With the change in policies, it now has to keep 38 crore with RBI. So, it has 1.6 crore rupees more to lend out of 1000 crore.
The first policy of repo rate change may look to contradict the other two, but they do not serve the same purpose. Repo rate change has been implemented to reduce inflation while the other two will ensure growth.
These developments were not actually predicted by the investors,as they felt that saving rupee from depreciating would be the RBI’s topmost priority. The rupee did slide down because of the rise in repo rate which to some extent will compromise on economic growth. “We are anti-inflation” said Rajan while announcing the new policies. He has adopted his alma mater, University of Chicago’s concept of curbing inflation first to ensure stability. Yes, he is indeed looking at the bigger picture and not for Facebook Likes! Being a sexy honcho is cool, but we need a matured badass decision maker more. And I believe Mr. Rajan won’t be disappointing!
Stay updated! There’s more surprises awaiting from our Rockstar Economist.
Latest Policy Rates by RBI (As announced on 29th October, 2013)
Bank Rate: 8.75%
Repo Rate: 7.75%
Reverse Repo Rate: 6.75%
Marginal Standing Facility (MSF) Rate: 8.75%
Cash Reserve Ratio: 4%
Statutory Liquidity Ratio (SLR): 23%