Time Consistency Problem and Expansion in INDIA....

The expansion of the Indian economy or the trade cycles have been short compared to the Western countries like the US that expanded over 10 years since the 08 recession and China that saw an expansion of 3 long decades, the expansion in INDIA has been short lived, less than 5 years, same as in the previous cycle after 08, attributed to overheating in the economy linked to food and fuel prices and higher cost of capital and incomplete communication by the policy makers, 

Like the central bank failed to provide the right forward guidance to the agents, especially the investors, both the foreign and domestic, which point to weak supply side given higher inflation and interest rate, too, on which the trade cycles depend, during the up cycle prices or inflation and interest rate increase, which further increase inflation and interest rate by lowering supply and employment and demand, too, and set the precedent for the down cycle or recession in which inflation and interest rate go down which again precede higher inflation and interest rate, that is a chain cycle, one is followed by the other…  

Nonetheless, in the current cycle the lower fiscal deficit has kept inflation and inflation expectations low since it directly increases employment and demand, when the monetary policy increases supply and investment and employment in the sectors that are overheating or have higher price or price expectations if the economy is below full employment. 

However lack of updated data on employment has made the polices prone to frequent changes in policy stance even when INDIA is underemployed and underinvested, which may lower inflation and inflation expectations if employment and supply increase with lower interest rate and expectations, the government has underscored its commitment to lower fiscal deficit and debt, but the monetary policy is slow to recognize this and has maintained a tight policy keeping the inflation targeting in mind when INDIA is supply side weak and needs more investment…  

Even the exchange rate regime has been such to increase imported inflation in the event of higher oil prices and inflation and depreciation, notwithstanding CAD has been low compared to the past, and lower fiscal deficit has helped lower depreciation, when there is a sect that is advocating higher exports to improve the CAD and foreign exchange earnings at a time there has been a hold on the private investment because of the higher interest rate that has also not let the exports to materialize and increased outflows of foreign exchange amid inflation and depreciation, further worsening inflation and depreciation, which the RBI is trying to correct by increasing the supply of dollars and reducing rupee liquidity which has increased interest rate on debt or bonds resulting in low investment demand, in the stock market, also.

Higher interest rate and expectations are bigger worry for domestic investment, including exports, bonds and stocks, too, than worsening cad and depreciation, which are dependent on the exchange rate management through foreign exchange reserves and exchange rate targeting to keep further outflows and inflation and depreciation in check... nobody complains appreciation in the exchange rate, but depreciation, which could help lower inflation and interest rate and expectations...

The problem is when the policy makers, especially the RBI, try to stop inflation or deflation and depreciation or appreciation, based on the text-books’ theories, they aggravate the problems, for example, if there is inflation and depreciation in the exchange rate in the economy, higher interest rate would exacerbate the problem of lower supply, imports, too, in a bid to lower demand, which also reduces employment and production that further increase inflation and expectations, on the contrary, when there is deflation and appreciation in the exchange rate, lower interest rate would further increase supply, imports too, that would again lower prices or increase deflation and both are always followed by each other and in this sense we might say that inflation and deflation are caused by the changes in the interest rate cycle or monetary policy cycle, the time consistency problem of the economic policies has been identified as one the most pressing concerns by Kydland and Prescott.

However, a constant and stable interest rate and exchange rate and expectations to achieve full investment, full employment and full output, exports-imports, too, would signify a stable prices and interest rate regime and could help agents adapt to movements, when a shock hits the equilibrium, a neutral real interest rate at full employment could help lower swings in cycles and adjustments….

   

Inflation and Depreciation and the US...

In the sameway, the RBI controls the money supply and the base rates to control domestic inflation and inflation expectations; it may also try to manage the market foreign exchange rate by manipulating supply of the foreign exchange and foreign exchange rate to control imported inflation and inflation expectations since price stability is the primary objective of the monetary policy… which might further reinforce lower prices by reducing inflation and interest rate and expectations which could extend the current economic expansion of the economy…

Inflation and depreciation and expectations are the prime causes of the foreign exchange outflows from the economy leading to further inflation and depreciation and expectations resulting in higher interest rate and expectations and lower investment and growth and expectations…

If the central bank is really serious to abide to the inflation targeting framework, to contain inflation lower than 4%, it may try to provide $s at a calibrated discount rate to the OMCs, as much needed, to reduce the cost and price of oils, which could help reduce inflation and expectations and interest rate and expectations, further reducing cost and prices to increase demand/supply and economic growth and expectations...

Lower prices would increase competitiveness of the economy and exports, too..... It is the objective of the central bank to control inflation and achieve full employment...

Nonetheless, if the RBI provides the foreign exchange at a discount rate through special windows to OMCs it would help contain cost and prices of oil imports and domestic inflation and might increase supply further lowering prices or inflation and interest rate and expectations and increase real wages and domestic demand and growth and expectations…

Lower prices or domestic inflation and interest rate and expectations might also increase the competitiveness of the domestic economy and increase exports through internal devaluation…

If INDIA does not resort to inflation and depreciate to increase exports, but follow to lower inflation and interest rate and contain real wages to increase productivity and competitiveness and exports it does not have to devalue externally, but internally ie internal devaluation...

We cannot expect much depreciation or external devaluation... It would also increase domestic demand... Lower inflation could increase domestic goods and services and currency exchange rate means higher real exchange rate.......

'Higher real interest rates have held back domestic investment even, leave alone exports... I would like to invite Rajan, the former CEA and RBI governor, to comment on higher real interest rate over 3%....' that how higher real interest rate could affect investment and employment and supply and demand and growth…

Lower food inflation in INDIA would increase real wages and demand and growth in the economy at a time when oil prices are betraying, it would help balance price pressure... If this has happened due to higher supply, farmers would sell more at lower prices means higher profits...

They have produced more for which lower prices are a remedy to consume over supply... Lower prices would help correct over supply and increase demand in the economy.... There is nothing like deflation in the agriculture or the economy...

Nonetheless, Government is a big player in the market if it restricts supply it might help contain prices...

Historically.... whenever the stock market has been through big corrections it has also increased more than the previous peak... it is a trend...... This time the stock market could touch 41, 000 to 42, 000 till March 2019 if domestic economy fundamentals remain stable....

The US companies or any country’s industries must understand that protecting their specializations would give them distinct competitive advantage over the long run... Specialization is the center piece of the theory of international trade and the theory of competitive advantage and comparative advantage...

In the veil of sanctions on Iran and Venezuela Trump is protecting its (US) Shale industry... It was widely expected that the Shale industry would bind the oil prices from increasing too much, but it has not... It is now a net exporter of oil which is also benefiting from higher oil prices.....

Oil Prices, Interest rate and Exchange Rate.... (Rev.)

Lowering oil taxes and prices were now an imperative for the economy supported by lower public spending... Lower inflation and interest rate and expectations could provide relief from battering rupee... even exports might not respond due to higher borrowing cost... This time cheap money could help reduce price pressure and maintain demand and supply, which have been suffering due to higher oil prices and dollar and borrowing cost... When everything is getting pricier cheap money could help maintain demand and supply... Lower borrowing cost alone could make things alot cheaper... The RBI must take note that demand has not increased and is not a reason for higher (oil) prices, but supply side has been weak, which could improve with lower borrowing cost... The RBI must communicate well what it really thinks might work in this situation..... Cheap money could make things a lot easier...

Higher interest rates would make the matter worse for importers... Their cost would go up further increasing imported inflation... The same with tariffs... Oil prices are increasing then dollar is increasing, then borrowing cost would go up... Where is the respite...? Demand is not the problem, but lower supply of oil and dollar are increasing inflation which could be further complicated by higher borrowing cost... To control inflation it is important that oil prices come down, if not, dollar must come down and even if not borrowing cost must come down..... Demand is already suffering due to higher oil prices and dollar; higher borrowing cost would further increase suffocation....

Raising interest rates would contradict with simultaneous OMOs and SLR cuts... The RBI is infusing liquidity to reduce effects of dollar selling and less rupee in circulation and hardening yields and less investment, which are responsible for outflows from debt market and depreciation and also outflows from equity further increasing outflows and depreciation... At this juncture stabilizing yields and expectations, if not rate cuts, could help increase foreign capital inflows in debt due to higher bond prices expectations and higher stock price expectations, because of improved investment expectations..... There is a case for the RBI to cut rates or reduce CRR to support its SLR cut and OMOs initiatives.....

Nonetheless, the RBI might also help reduce the oil prices... if the RBI sells dollar at a discount rate below the market price around Rs 50 to the oil companies, they would be able to buy oil at lower cost or for less Rs which could be passed on to the consumers in the form of lower oil prices leading to further lower inflation and interest rate and expectations... So far the RBI has sold dollars at the market price that has helped little and reduced money supply and increased interest rate in the domestic economy and increased inflation and inflation expectations owing to higher oil prices... However, if the RBI sells dollar at the discount rate it would lower oil prices, inflation and interest rate and expectations resulting in higher economic growth.... RBI is no profit institution... It''s objective is to maintain low inflation....

Lower fiscal spending is good for lower inflation and depreciation, too... which could help lower interest rate and expectations... We should recognize the government’s efforts to control fiscal deficit and debt which had been a prime cause of inflation and depreciation and higher interest rate under UPA... Nonetheless, inflation under NDA is at manageable levels which could be further brought down with good policies... We need to anticipate problems of the Indian economy in order to devise proactive polices, which could help increase productivity and competitiveness... Today inflation is under 6% whereas under UPA it shot above 12%... Nonetheless, there is still a lot needs to be done to improve the supply side, from where inflation may creep in, in the economy for which lower interest rate may help improve domestic investment and supply..... Higher prices increase supply when the borrowing cost is low and lower public spending may help utilize resources, like labour and capital, by the private sector.....

Domestic oil industry is now a priority sector given higher oil prices, which might be provided interest or exchange rate subvention to increase production and supply and lower inflation and interest rate and expectations further... Higher oil prices have exacerbated dollar demand and depreciation for which increasing domestic oil production could help lower oil imports, prices and dollar demand, nonetheless domestic oil production has gone down in the past months which has also increased the demand for oil imports... The government may try to partly settle oil imports in rupees or goods to avoid dollar demand and depreciation... Oil is a priority for the lower prices and interest rates and the economic growth rate..... INDIA needs to emerge as self dependent for oil if it wants to lower interest rate and expectations and increase growth.....

Ad Valorem taxes are imposed on nominal value of oil, however higher oil prices were not expected in the estimates or higher oil prices were not anticipated, but higher oil prices must increase tax collection or reduce revenue deficit and fiscal deficit...