Why RBI May Not Reduce Policy Rates Prematurely To Boost GDP   Dec 16, 2016


December 16, 2016
Weekly Facts
  Close Change %Change
S&P BSE Sensex* 26,489.56 -257.62 -0.96%
Re/US $ 67.84 -0.48 -0.71%
Gold Rs/10g 27,350 -830.00 -2.95%
Crude ($/barrel) 52.78 0.04 0.08%
F.D. Rates (1-Yr) 5.60% - 7.10%
Weekly changes as on December 15, 2016
BSE Sensex value as on December 16, 2016
Impact


The impacts of demonetisation on economics are even more visible now.

Retail inflation, as measured by the movement of the Consumer Price Index (CPI), has fallen to a 2-year low. CPI inflation for the month of November stood at 3.63%. Fall in the prices of perishable commodities such as fruits and vegetables has led to such a sharp drop in the headline inflation. The food price inflation came in at 2.11%. But, this is not to say that the supply of fruits and vegetables improved substantially or demand fell drastically; the cash crunch hindered the trade of these commodities, which transacts almost entirely in cash, resulting in a distress sale. The favourable base effect has also helped to an extent.

The vegetable prices slid by 13.73% while prices in pulses recorded a sharp cut of 8.77%. However, the core inflation, i.e. non-food and non-fuel inflation, moderated only marginally. Clothing and footwear, housing, and other miscellaneous segments recorded a growth of 3.46%, 5.04%, and 4.03% respectively.

Sliding inflation: a demonetisation effect

(Source: MOSPI, PersonalFN Research)


Many experts, economists, and market participants have now started speculating on the possibility of RBI cutting policy rates at the sixth bi-monthly monetary policy review scheduled on February 07, 2016. A few believe the RBI may lower rates even before that.

At the fifth bi-monthly monetary policy review, it had held policy rates unchanged.

RBI expected the effects of demonetisation to be transient. Surprisingly, the impact of demonetisation on the inflation would be only in the range of 10-15 bps. In contrast to popular belief, RBI anticipated the firming up of food prices led by Sugar and confectionery products, cereals, protein rich food, pulses and processed foods among others. Surprisingly, it didn't see any risk of core inflation sliding substantially.

In fact, it feared the recent trend of falling inflation might only be temporary as the favourable base effect enjoyed in October won't be available for months to come. Moreover, effects of OROP (One Rank One Pension) and 7th CPC (Central Pay Commission) haven't played out completely as yet. Having said that, the central bank remained confident about being able to achieve the retail inflation target of 5.0% by the end of Q4FY17. 

The RBI revised the GDP estimates from 7.6% to 7.1%. It believed a strong performance of the agricultural sector and revival in consumption riding piggy-back on the implementation of OROP and 7th CPC would negate the impact of demonetisation. The downward revision in GDP was based mainly on the downward revision in the Q2FY17 numbers. 

What to expect?

The RBI might surprise the proponents of lower interest rates by maintaining policy rates unchanged. Let's not forget that, the yields on the U.S. bonds are rising and US$ index has been witnessing an unprecedented surge. Under such conditions, if RBI slashes policy rates, the Indian bonds might see outflows. Recently, the Federal Reserve (Fed) raised target rates for federal funds by another 25 basis point (bps). A basis point is one-hundredth of a percent. This has been the second rate hike ever since the U.S. Fed started unwinding its loose monetary policy stance. Moreover, the guidance remains slightly hawkish too. In 2017, the Fed might increase interest rates thrice.

RBI would be watchful of such events as rising US$, and shrinking difference between U.S. bond yields and Indian bond yields may disrupt the Indian bond markets. Reduction in the crude oil production by OPEC (Organisation of the Petroleum Exporting Countries) and firming up of oil prices in the international market may trigger inflation in India.

These two factors, when put together, would have an inflationary impact on India. Nonetheless, RBI foresees the Current Account Deficit (CAD) to remain subdued. 

The sixth bi-monthly monetary policy review is scheduled on February 07, 2017—post budget. By then, RBI would get more time to further assess the impact of demonetisation on the economy as a whole, with a particular emphasis on inflation and economic growth. Clarity on crude oil prices and the foreign exchange movement would further facilitate decision making on the policy.

As of now, it is premature to comment on how RBI might interpret these developments. PersonalFN believes, you shouldn't speculate on any macroeconomic developments and should invest across asset classes as your personalised asset allocation plan guides you.

Impact


If you think you have forgotten to report facts or unintentionally misreported something in your income tax return, you get a second chance. Therefore, filing a revised return is a common practice for taxpayers, in particular for those who have business income. They have to maintain lots of records that include, statement of accounts and balance sheet, so making an error is common. However, the Income Tax Act, 1961, allows a revision of returns only in genuine cases.

If you are planning to file a revised tax return for the Financial Year (FY) 2015-16, be careful. The income tax department might be watching you closely. In the aftermath of demonetisation, it seems some taxpayers are resorting to revising their income tax returns.

Why?

Demonetisation has spooked many business persons who held significant amounts of unaccounted cash. In an attempt of legalising this cash holding, they might be tempted to revise returns of FY 2015-16 and show a higher amount of ‘cash in hand’. This would give them a chance to deposit unaccounted money into banks. But as the Finance Minister has already clarified, merely depositing money into a bank account won’t absolve black money holders from their sins.

To add to their worries, the tax department has also issued a circular warning against any such malicious acts. The statement read as, "It is brought to the notice of tax payers that any instance coming to the notice of the Income Tax Department which reflects manipulation in the amount of income, cash-in-hand, profits etc. and fudging of accounts may necessitate scrutiny of such cases so as to ascertain the correct income of the year and may also attract penalty/prosecution in appropriate cases as per provision of law.”

PersonalFN is of the view that instead of trying to cook accounts and earn a bad name, those with unaccounted cash should declare their assets under Pradhan Mantri Garib Kalyan Yojana (PMGKY). Similarly, those allowing black money holders to deposit cash in their accounts may invite trouble for themselves. PersonalFN suggests its readers and investors to refrain from engaging in such activities.

Impact

It has been over a month since India demonetised Rs 500 and Rs 1,000 notes. As over 86% of India’s currency went out of the system overnight, hardships for the common man was a given. However, people at large were ready to suffer this initial pain for ‘long term gains’. The entire implementation process of demonetisation has taken many twists and turns so far. What’s perplexing is, contrary to the expectations of the Government, 80% of demonetised currency has already returned to the system. What’s more confusing is the sudden rise of the ‘digital money’ campaign. 

Although the Narendra Modi Government has been encouraging people to exercise the option of plastic money for a considerable time now, the attention it has received, particularly over the last fortnight, points at something more. Has demonetisation failed and now the ‘incentivising’ of digital payments is a con man’s move? 

A list of unanswered questions about the success of demonetisation probably competes with long queues outside banks. Interestingly, except some top political leaders who went to banks with ‘photo op’ moments in their mind, the entire political clan got door-to-door service from bankers. If not then, maybe they were using digital money. But that’s too ideal to be true. 

The income tax department has been raiding across the country, seizing cash. The policemen are taking bankers into custody, who seem to have perpetrated frauds in allowing black money holders channelise their cash. 

Recently, the PM, in a political address, appealed to the people whose Jan Dhan accounts have forcefully been used to stash cash, not to return a single penny to its original owners. However, people acquainted with such developments believe this advice is vastly detached from the ground realities. They feel if people were to follow this advice, not only would their lives be in danger, but members of their family would not get a job in their locality.

To read more about this story and Personal FN's views over it, please click here.

Impact

Every honest taxpayer expects a fair Government to revise tax slabs and lower tax rates. Until now, dishonest people managed to dodge taxes by exploiting the loopholes in the system. Going forward, they would find it difficult to manage their black money and escape from the eye of the taxman—thanks to demonetisation. At least, India’s Finance Minister, Mr Arun Jaitley believes so. Recently, speaking with the media he said, “Future transactions would be substantially digital and once they are substantially digital they get caught in the tax net." 

The Government is hopeful the digital drive will not only help boost its revenue but would also ensure that a significant chunk of cash stays within the system—a pre-requisite to low-cost funding.  Besides, to deal in cash, mentioning the Permanent Account Number (PAN) would become prevalent and the roll out of GST would further discourage cash transactions in the economy. These factors, according to the FM, would lead to lower corruption and higher reforms

Is this only positive thinking, or there is any silent message for taxpayers that the tax rates will drop in future? 

Well only time can tell; but for now, it is nothing more than mere speculation. It seems the Government is trying to hide its failure in the implementation of demonetisation which is why it's painting such a rosy picture. 

How can it turn a blind eye to some blatant instances of corruption that have happened soon after it scrapped high denomination notes? The Police have taken RBI officials into custody for facilitating illegal currency exchange. Many bank officials have been facing similar charges. Government employees have been caught red-handed accepting bribes even at a time when there is an inadequate supply of cash. Rs 2,000 notes would facilitate corruption and not prohibit bad practices once the money supply improves.

The digital payment campaign too appears a last minute arrangement. If not, then that too was planned badly. In that case, only the Government knows how a digital payment campaign can succeed when India has abysmally low penetration of debit and credit cards. It is better not talk about digital wallets whose use is mostly confined to the educated urban spenders.   

MPs and MLAs have been spending crores of Rupees on weddings and private parties, at a time when the other citizens are standing hours in queues just to get a few notes of their hard-earned money. Is it a case of total disdain or a new-norm? 

To read more about this story and Personal FN's views over it, please click here.



The Government has yet to take a decision about bringing Rs 1,000 notes back in the circulation, and the images of new Rs 1,000 notes have gone viral on the social media. This has given rise to rumours that the RBI may sooner or later make the formal announcement. RBI and the Government seem to have agreed on the specifications of the new notes, and the printing has also started on a pilot project basis.

One may think that after demonetisation, continuing with the high denomination notes would serve no purpose. But it remains to be seen as to what would be the new monetary base of India? If the total value of currency notes in circulation is reduced drastically, high-value notes may not lead to high level of corruption and black money generation. The Government would be keen on tackling the problem of black money by taking additional measures. There is also a speculation that high denomination notes are introduced only as a temporary arrangement. Once the adequate stocks of lower denomination notes are built up, the RBI may gradually absorb these high-value notes without any formal demonetisation. For now, these are only guestimates.

However, what's clear is—the digital payments is the way to go.



Base Effect: The consequence of abnormally high or low levels of inflation in a previous month distorting headline inflation numbers for the most recent month. A base effect can make it difficult to accurately assess inflation levels over time. It wears off over time if inflation levels are relatively constant.

(Source: Investopedia)

Quote: "Inflation is taxation without representation "- Milton Friedman


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