Wednesday 3 June 2015

Goldilocks Policy in India

The crux of  News
Recently RBI Governor summed the scene of rate cut in June 2015 and used the term while delivering the bimonthly credit and monetary policy:
"I would characterise the policy today as neither conservative nor aggressive. It’s in some sense a goldilocks policy. Just right given the current situation."

To understand above statement we need to understand the complete background, which has been discussed as following.
  1. RBI thinks that there is going to be increase in inflation 
  2. But growth is also necessary which is showing poor signs in India
  3. So they gave minor relief of repo rate cut as they felt that inflation would be manageable under target and legal limit of 6%.
Above 3 points have been discussed below in detail after which we will understand the RBI Governor's statement about Goldilocks Policy.

Risk of Inflation
  • The Reserve Bank of India (RBI) on 2 June 2015  cut repo rate by 25 basis points i.e 0.25% and at the same time it spoke of potential price pressures and raised its calendar year-end projection for retail inflation (from 5.8 to 6%). 6% is also the infaltion target set up by RBI under the new monetary policy.
  • Risks include: 
  • Given these potential risks to inflation, it’s worth asking why the RBI went ahead with a rate cut. Why didn’t it wait until a clearer picture emerges on the monsoon front?
Why growth is poor and needs support in RBI's assessment?
  • Conditions on the ground have just not improved despite the noise about India becoming the fastest growing economy.
  • Weak rural demand
  • Low level of capacity utilization
    • it has fallen across several industries
    • it also shows that much private investment is not happening. 
  • Weakness in exports
    • Net exports aren't likely to contribute much to growth against the current global backdrop. Growth will have to depend only on domestic demand. 
  • RBI, in its policy statement, spoke of sustained weakness in consumption spending, especially in rural areas. This was indicated in the sales of two-wheelers and tractors. This is expected to continue to act as a drag on the economy.
  • All taken together, the economy continues to operate well below potential (Which under  the new data series is seen at 8-8.5%)
Though right time would have been to know the exact status of Monsoon and the government response to it but still RBI went for it and this was admitted by RBI also saying that a more “appropriate stance” is to “front load” the rate cut and then wait for data to clarify the uncertainties. Moreover RBI has a medium-term objective of keeping India on a disinflationary path.
Now, a Goldilocks Policy is one in which there is moderate economic growth and low inflation, which allows a market-friendly monetary policy i.e. giving cheaper credit.
  • Goldilocks economy is characterised by:
    • Low unemployment rate, 
    • Increasing asset prices (stocks, real estate, etc.), 
    • Steady GDP growth
    • Low inflation
    • AND Low interest rates
The two extremes of Goldilock economy are:
  • A bullish economy: 
    • Steep growth in market values +  low losses due to inflation --> Economic growth
    • It may lead to rising inflation. 
  • Bearish economy:
    • Stagnant economic performance + inflation rates soaking up any gains. 
In above two cases RBI acts to either cool off or heat up the economy, primarily by raising or lowering the official interest rates. When there is a balance, i.e. not rapid or stagnant growth, but sustained growth and a reasonably low inflation rate, it is a comfortable zone for investors to find long term growth and attractive values in various asset classes. 

Therefore, experts have labeled this balance between a bull economy and a bear economy, the Goldilocks Economy.

Origin of the name Goldilocks Policy comes from children's story: The Story of Goldilocks and the Three Bears

A little hungry girl named Goldilock, walks into 3 bear's kitchen and finds three bowls of porridge. On eating she finds the first bowl too hot and second too cold and third one just right and eats it all.

To have some rest then she sits on the chair in living room. Again same thing happens. First and second chair are too big and finds 3rd to be a perfect fit. But 3rd ones breaks the moment she sits on it. Then she goes to bedroom. Found 1st bed too hard, second too soft and third was just right. And then she sleeps on it.
Meanwhile the three bears discover it all and Goldilock screams seeing them and runs away from home. And She never returns to the home of three bears. 

Short Summary of the news above:

At present Indian economy is neither having great inflationary phase nor hot growth period. 

Manageable inflation
The increase in inflation has been estimated to be at 6% which is the legally permissible limit for RBI to maintain inspite of rising inflationary risks arising out of various reasons as discussed ahead. The inflationary risks are: Poor monsoon, rise in oil price and volatality in external environment.  Moreover, RBI governor recently announced repo rate (the rate at which RBI lends money to banks on short term basis) cut by 25 basis points. Cut in Repo Rate leads to increased liquidity, which can lead to increased demand and thus be inflationary in character. Inspite of above, owing to a combination of reasons like better administration, new zeal in foreign policy, stable government etc., inflation has remained within manageable limits.

Average Growth
Further the growth story is also average only owing to weak rural demand, lack of capacity utlisation and weak exports even though government has taken a lot of measures like Make In India programme, Opening up of Defence sector, increasing clarity in tax laws, better budget allocations, replacement of Planning commission with Neeti aayog etc. 

This combination of manageable inflation and and average growth makes Indian economy fits somewhere in between bull and bear economy accompanied with low unemployment rate (atleast it is decreasing at whatever rate) and increasing assets prices (even if it is not a great increase). 

In economic jargon this situation of India, which is neither conservative nor aggressive, has been termed as Goldilock's economy.

Indian 'economic bowl' is truly the "Goldilock's porridge bowl", which is just right for her.


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