Since the last 15 months or so…RBI has been trying to battle the rising inflation by raising rates (What are policy rates?) eight times since March last year. However inflation, now it seems, is getting out of RBI’s control. Over the last one year, there have been many a concerns over structural bottlenecks in the economy which have been causing inflation. Well this might be true, I am not arguing against that. But even if Government decisively acts against structural cause of inflation, it would be some time before anything (like improving storage warehouses, improving transportation facilities, improving public distribution system etc) can be done and it impacts the mighty inflation.

The onus thus totally has been on RBI to manage or rather control inflation. Governor Dr Subbarao is trying to get atleast his inflation forecast right by constantly revising the inflation expectations upwards in all the subsequent policy reviews rather than taking aggressive steps to curb the price rise. Till now RBI has been taking baby steps by raising 25 bps almost every 45 days. The same has had an impact on inflation but only marginally so.

Inflation going forward

As per the last release, WPI for March’ 2011 rose to 8.98%, shying away from the 9% mark. Going ahead, I expect price pressure to see more upside post elections due to long pending diesel price hike. Good monsoon forecast by IMD may cool down the expectations but it would be some time before which the same may actually impact the primary articles price. Going by last year’s experience, even good monsoons might not have any impact on the prices.

Compromising growth

Growth, which is a trade off for higher interest rates, has been moderating.  Latest GDP showed slight moderation in the last quarter’s growth rate. It is still some time before we get the first quarter’s growth rate. IIP numbers have also been moderating. Inspite of this moderation, I feel there is still some room for RBI to compromise on growth front. As i said in my last post on the same topic (Monetary Policy January), rates are still way below the highs observed during last growth phase before Lehman Brothers fiasco and another 100 bps on repo would not put the economy in any sort of trouble.

RBI clearly has two choices, either to let inflation chop off a few points from the growth rate or to itself step on the growth temporarily and try to tighten its grip on inflation. At the same time, it seems there has been some lag in the transmission of tight monetary policy to the commercial banks. Deposit rates and credit rates to general public have not been impacted to a large extent. Cheap home loan rates existed till recently. SBI put an end to its teaser loan rates only in the last week upon pressure from RBI.

Expectations and impact on equity markets

Thus in the coming monetary policy announcement on May 3, I would expect Mr Subbarao to come down heavily on inflation by going for a more aggressive 50 bps hike in repo rates and take steps to induce commercial banks to raise deposit and lending rates.

If both these factors are accepted by RBI, markets would be looking for some more downside even after a 135 points fall since April 21. Banking stocks would obviously be worst impacted who would be forced to raise atleast the rates and sacrifice their margins.

Author:Praveen Bajaj

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I will leave the issue of importance of monetary policy for a future article and in this article would express my views on RBI’s announcements on January 25, 2011.

The way equity markets took a beating of about 400 points in 6 trading days from Jan 4 to Jan 11, it seemed that markets have discounted all the future increases in interest rates in that 1 week itself. I heard some of the traders even guessing a 75 bps hike in the instant policy announcement itself.

With inflation not showing any signs of cooling and Government also seemed to have exhausted all the available options for controlling the monster, RBI was seen as the messiah for controlling inflation.

But growth on the other hand was also a concern. Industrial production grew at meager 2.7% rate for November. Also couple of overseas investment bankers were seen reducing their bets on Indian markets due to high inflation and thus higher interest rates.

Thus speculations were ripe about the quantum of raise-25 or 50 or 75 bps hike. RBI however did not surprise markets and kept the rate hike to a moderate 25 bps. Equity markets jumped on the announcement but considering the more than usual hawkish stance of RBI in the policy document started covering up for the gains.

Without taking any numbers, I would expect RBI to increase policy rates again in the mid-term announcement on March 17. Policy rates are still good 250 bps below the peak levels seen last time. Along with this, rising global commodity prices and persistently high food prices inflation has high chances of becoming broad based.

This would keep RBI on its toes as it tries to kill inflation evil created without any of its fault.

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Highlights of the mid-quarter review released on September 16, 2010

• Repo Rate hiked by 25 bps to 6%, with immediate effect from 5.75% currently
• Reverse repo rate hiked by 50 bps to 5% with immediate effect from  4.5% currently
• LAF corridor has been again shrunk to 100 bps from 125 bps earlier
• CRR has been kept unchanged at 6%
• RBI has said that inflation appears to have been plateaued and recent policy measures have been impacting demand and inflation
• RBI has observed that real rates must be hiked to aid bank deposit growth

Economic scenario

Economy recorded a growth rate of 8.8% during the first quarter of the current fiscal. This has been the highest quarterly growth rate since the December’2007 quarter.

• Monsoon has been good this year and crop production is expected to be far better than last year. Good monsoon can impact the economy in two ways. On one hand, where good crop will release the pressure on food prices, on the other hand, this would put purchasing power in the hands of rural households and create demand for goods and services which might create an upward pressure on inflation. Nevertheless, good monsoon, for the current year creates good growth prospects for the economy.
• Industrial production has been growing at a good pace in the current year till now. Barring for the month of June, when IIP grew at a meager 5.8%, the index has shown a robust performance for the year till now. Leading indicators for service sector  activity also point to a good growth
• Inflation has been seen moderating over the last few months. Food prices’ index and primary articles’ index both have been moderating. With new series, the index is likely to show a slightly relaxed picture of inflation. But still, inflation is still above the target level of 6% for the March’2010 level and there still remain upward pressure on inflation. RBI, in its press release has observed that, inflationary pressures are still likely to remain at high levels for some months.
• Liquidity conditions remained in surplus level for some time, but again since last week there has been a deficit and banks have been borrowing from the Repo window. As on today, banks have borrowed Rs 51,850 Cr through the LAF facility. Liquidity conditions are expected to remain in the deficit as economy enters the busy second half of the year. With credit off-take expected to pick up, banks would need more funds to conduct their business.

Impact of the moves

• Since March 19, 2010, the Repo rate has been increased by 125 bps to 6%. And since May this year, SCBs have been net borrowers from RBI through its LAF Repo window. Increase in rates will increase the borrowing costs of the SCBs and impact the profitability of banks.
• Shrinking of LAF corridor will reduce the volatility in interest rates. With volatility in interest rates, SCBs get arbitrage opportunities in the money market and LAF. With shrinking corridor, these opportunities would get reduced. This move of RBI is in line with the aim to move to a single policy rate regime consistent with international standards.
• Earlier monetary moves have started showing impact on the moderating inflation. This move will further contain inflation and inflationary expectations which are expected to remain at an elevated level for some more months.
• Both money markets and equity markets had already factored in the rate rise. Post the announcement, equity markets have resumed on the bullish trend and have risen from 5830 just before the policy announcement to just under 5900 by 1 pm. Benchmark 10 year yields have also risen by 5 bps after the announcement.

The tone of RBI’s announcement is still on cautious with respect to inflation. It has kept the doors open for further rate hike with expectation of high inflation in the coming months and good growth prospects. We can expect some more action from RBI in the next quarterly review on November 2.

Author:Praveen Bajaj

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The benchmark indices were almost flat after the data release while there was also no major movement in INR. The RBI in its monetary policy review in mid-September now, is not expected to increase the interest-rate as it had said earlier that it would wait for the inflation figures to consider any further hike in the interest-rates

• The sub-group of primary articles rose by 14.94% y-o-y against 7.64% in July’09.It registered a growth of 1.85% m-o-m mainly because of high growth in the food articles, which increased by 0.90% m-o-m. Food articles increased more than last month due to rise in prices of mutton, fish milk, eggs, cereals and pulses
• In the same sub-group, the non-food articles increased by 0.80% m-o-m due to higher prices of fodder, oil-seeds, raw jute, rubber and silk and increase in the price of copra, etc. The index for minerals rose to 19.25% m-o-m which was due to higher prices of flluorite, magnesite, iron ore and steatite
• The second sub-group of fuel, power, lights and lubricants increased to 14.29% y-o-y from -10.37% in July’09 which was pretty high. It registered a growth of 3.21% m-o-m due to higher prices of LPG, high speed diesel oil, aviation turbine fuel and petrol
• The third sub-group of manufactured products jumped to 6.15% y-o-y from 0.10% in July’09. It registered a degrowth of -0.14% m-o-m mainly because of increase in the prices of edible oils, manmade textiles plastic products and machinery and machine tools
• Food products declined by 0.61% m-o-m due to lower prices of bran, butter, khansari, coffee powder and gur. Sugar prices declined by 2.55% while there was an increase of 1.27% in edible oils due to higher prices of oil-seeds. Cotton textiles and man-made textiles surged by 0.38% and 0.48% due to increase in the prices of raw cotton, jute, raw silk and fibres. Rubber and plastic products increased by 0.06% while machinery and machine tools increased by 0.22%

Author:Rahul Sonthalia, Research Head, Kredent

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RBI Governor, Dr D V Subbarao announced the first quarterly review of monetary policy today. The measures taken were quite on the expected lines (Read our article on monetary policy expectations).

• Benchmark Repo rates hiked by 25 bps to 5.75% with immediate effect.

• Benchmark Reverse Repo rates hiked by 50 bps to 4.50% with immediate effect.

• The interest rate corridor between the Repo and Reverse Repo window reduced to 125 bps from 150 bps.

• CRR, SLR and Bank rate kept unchanged at 6%, 25% and 6%, respectively.

• Baseline inflation projection for March 2010 increased to 6% from 5.5%.

• Baseline estimate for GDP growth for 2010-11 revised to 8.5% from 8%.

• Bank deposit growth target of 18% maintained for FY2010-11; Bank deposit growth stood at 15.0% year-on-year as on July 2, 2010.

• Bank credit growth target of 20% maintained for FY2010-11; Bank credit growth stood at 22.3% year-on-year as on July 2, 2010.

• RBI to undertake mid-quarter policy reviews starting September 2010.

Impact of monetary policy

• As expected, RBI has raised the policy rates. This is the fourth rate hike since March this year raising the Repo by a total of 100 bps and Reverse Repo by 125 bps. Moving differently from earlier moves, the quantum of change in the policy rates; repo and reverse repo is different (What are policy rates?). The Liquidity Adjustment Facility (LAF) corridor has been shrunk to 125 bps, a change first time since November’2008.

What this means?

Short term interest rates, particularly, interbank repo market rates hover in between the LAF corridor in order to prevent arbitrage opportunities for the banks. Because of tight liquidity conditions, short term rates have been quite volatile. This measure is aimed at containing this volatility in the rates.

• Since end-May, banks have been borrwoing from RBI through its LAF Repo window. Out of four rate hikes since March, two were effected when there was ample liquidity in th system. But the last two have come at a time when the liquidity conditions have tightened. Thus interest cost of banks will go up. Assuming that banks will borrow about Rs 50,000 cr for the year as whole from Repo, the combined efect of the last two hikes will shave off about Rs 250 cr from banking sector’s profits.
• What would also hurt banks’s profitability is that deposit rates have also risen. Thus lending rates, in general will go up in order to protect net interest margin (NIM).
• Inflationary expectations have driven RBI to raise the rates. Policy stance of RBI has shifted to “to containing inflation and anchoring inflationary expectations”. RBI has noted that inflationary expectations have firmed up. Accordingly, RBI has also raised the projection for end-March 2011 to 6%. RBI has commented that it will continue to take actions to counter inflationary expectation.
• Though RBI has not hinted at further rate hikes, but its strong concern for inflation implies that good growth prospect along with continued high inflation will in make it imperative fro RBI to increase rates.

Author:Praveen Bajaj

Related posts:

1. RBI Monetary Policy 2010
2. Annual Monetary policy 2010 – Highlights
3. RBI likely to raise rates in todays monetary policy review

Inflationary concerns

RBI has time and again stressed on its concerns on inflation. In the last policy announcement RBI had anticipated that inflation will come down in a gradual manner. But inflation is still reigning in double digits. For June, WPI increased by 10.6% over last June. Increasingly, it is seen that inflation has become more broad-based and manufacturing as well as fuel price inflation has also been rising. For food articles as well, though the growth rate is moderating, but is still at high levels and is not expected to go down substantially unless new crop comes in the market which would be only towards October. Thus inflationary concerns are quite strong and RBI would like to take some action to tame it.

Economic Growth

Economic activity has continued to grow at a good pace. GDP growth for the last quarter was above 8% and for the next year, the growth rate is expected to be higher than last year. IMF in its last World Economic Outlook (WEO) update has projected a growth rate of more than 9% for India in the current year. In recent months, IIP has moderated but is still growing by double digits and some sectors in IIP are showing very good growth. Monsoon has been good till now implying that agricultural growth will also be good and give a boost to the farm income and rural spending levels. This will support RBI’s decision to raise rates.

Liquidity and interest rates

Liquidity conditions have tightened significantly since the last policy announcement. Since May end, when telecom companies made 3G and Broadband wireless access (BWA) payments to the Govt, liquidity has dried up. Banks have been borrowing on an average above Rs 50,000 cr from RBI from its two repo windows on a daily basis. Short term rates (90 day Commercial paper, 90 day T-Bill, call rates) all have moved up. Long term yields, though had come down by about 50 bps from the levels seen in April, but after the July 2 hike in policy rates have hardened by about 20 bps.

In a short time, Dr D V Subbarao is going to announce the First quarterly review of monetary policy and he likely to increase the policy rates by 25 bps.

Author:Praveen Bajaj

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1. RBI Monetary Policy 2010
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In an after market hour announcement today, RBI raised the repo and reverse repo rate by 25 bps each to 5.50% and 4% respectively (click here to read about repo and reverse repo rates).

Inflation

Anticipation of a rate hike got all the more eminent after the decision to raise the fuel prices and freeing up the price of petrol last week. The move was expected to raise the WPI inflation by about 90 bps. For the month of May, WPI was at 10.16%, above the 10% mark. Though food inflation has been easing, other major indices, fuel index and manufactured products inflation has been rising. RBI in the release noted “There has been some moderation in food price inflation, but the price index of food articles continues to increase. More importantly, the prices of non-food manufactured goods and fuel items have accelerated in recent months”.

Money markets

As compared to earlier rate hikes, this rate hike assumes all the more importance as money markets are facing liquidity crunch. Volumes at repo window have been high during the week, averaging about Rs 60,000 cr for the week. Call rates are also high. This would increase the cost of borrowing of the banks. As for liquidity, RBI has extended the time limit for additional liquidity support and second LAF window till July 16 to ease the liquidity conditions.

Rates of banks

However, it is expected that it would still not lead to an immediate rate hike by the banks as base rate mechanism of pricing loans is being implemented from July 1. Impact of the same on corporate borrowing will be determined only after some time. Thus as of now, corporate borrowing may not get affected.

Market reaction

Since this announcement was done after the close of all the markets, there has been no reaction of the markets. However equity markets have been in negative for most part of the week and still indices are expected to open weak on Monday. Yields on bonds increased after the fuel price announcement last week but the same retraced back most of the gains during the current week. But for the next week again, yields are expected to open strong on Monday.

Author:Praveen Bajaj

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2. RBI likely to raise rates in todays monetary policy review
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There are 4 big events in the month of July because of which I believe markets may end lower in the month of July

1. First which I had already discussed in my previous post is the $30 billion IPO, by the China AG bank,
which could suck the liquidity out of the emerging markets and thus leading to a fall

2. Second in July only, perhaps in the later half of the month the EU will come up with its bank stress test
results and without any plan so as to how it would provide any kind of support to the ill banks the results
may provide another reason to sell the financials and other related stocks around the world

3. Third, from 17th July, Nifty futures will be traded on CME and this move is taken in order to facilitate US
investors to take exposure in Indian markets without facing the hassles of cross border investing. This, I
believe might lead to a liquidity crunched Indian markets

4. On 27th July, is the RBI Q1 credit policy, with statements from the governor that inflation being the
bigger concern than the EU crisis, and the recent fuel price hike, I believe it sets a strong case for the
RBI to go for a rate hike (and I think it might come as a surprise well before the actual policy date). The
Indian banking system which is already liquidity crunched because of the 3G and BWA auctions could take
a serious hit if this happens. The Bank Nifty falling by around 3% on Friday just after the fuel price hike,
signals the market expectations of a rate hike.

Thus, I believe that the best one could do in July, is to avoid long position and traders can also use low IVs as a tool to go short using the put options.

Be Cautious & Happy Investing…!!!

Author name:Rahul Sonthalia, Research Head, Kredent

To see other posts by the same expert click here

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• CRR hiked by 25 bps; to absorb Rs. 125 billion from the system
• Benchmark Repo and Reverse Repo rates hiked by 25 bps each to 5.25% and 3.75% respectively
• SLR and Bank Rate kept unchanged at 25% and 6%, respectively
• Bank credit growth expectations increased to 20% in fiscal 2011, compared to 17% in fiscal 2010
• Bank deposit growth expectations increased to 18%, marginally higher than 17% reported in fiscal 2010
• GDP forecast hiked to 8.0% with a positive bias for fiscal 2010-11 as compared with expected 7.2-7.5% in fiscal 2010
• Inflation, as mesured by WPI, estimated to moderate to 5.5% by March 2011
• Policy stance is to support “non-disruptive” growth in demand for credit while anchoring inflation expectations; to maintain an interest rate regime consistent with price, output and financial stability
• Banks‟ investments in Non-SLR Bonds of infrastructure companies with residual maturity of more than 7 years allowed to be classified under HTM category
• Provisioning requirement for sub-standard unsecured infrastructure exposures reduced to 15% from 20%
• Scheduled Commercial Banks (SCBs) and Non Bank Finance Companies(NBFCs) with networth more than Rs. 10 billion to migrate to IFRS converged Accounting Standards by April 2013
• Discussion paper on mode of presence of foreign banks by September 2010
• Discussion paper on guidelines for new bank to be placed
• Differential regulatory treatment for Core Investment Companies with asset size of over Rs. 1 billion

 Click here to read our projections of the monetary policy.

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Finally the D-day is here..the day when RBI Governor Dr.D Subbarao will announce the monetary policy putting (or rather saying probably putting) an end to the much speculated move of RBI..will it hike the rates, which rate will be hiked and how much..before RBI announces the rates here is MoneyBol’s take on the same…

Inflation

As known to all, inflation is the biggest concern for RBI. In our  Inflation WPI March 2010 update a few days back, we saw that the inflation rate, has already crossed RBI’s target of 8.5%, The YoY inflation number of 9.9% for March 2010 is much higher compared to 1.2% observed a year earlier. The food articles have risen 16.65% since March 2009. The manufactured products too have sharply risen by 7.13% since March as compared to 2.29% observed a year earlier. Measures to alleviate pressures from excess liquidity that may exacerbate inflationary concerns have been taken by the Central Bank earlier. Liquidity had been curtailed via a CRR hike of 75 bps in the January Policy.

Mr. C.Rangarajan, Chairman, Prime Minister’s Economic Advisory Council (PMEAC) remarked “The RBI may want to wait for a few weeks to see if food prices will decline on account of the rabi output. Then it might want to tighten liquidity and if inflation still persists, then it will act on policy rates”

Going forward, inflationary concerns are expected to subside slowly with forecasts of normal monsoons, better crop production, good performance of manufacturing sector and lagged effect of monetary policy changes. On the upside risk of rising crude oil prices remain which could trigger inflation again.

Industrial Production

IIP is still growing at double digits and poses good for the economic growth of the country. However in the last month’s release, it seems that IIP seems to be moderating. As stimulus measures are wound up, IIP growth will be mainly driven by domestic demand. Thus in the coming days, IIP may not be able to post the god growth that has been observed post June 2009. A moderation in IIP growth may prevent RBI from taking aggressive measures.

Liquidity

Since the last 75 bps hike in CRR in February, liquidity has come down from the highs of +100,000 cr mark seen in January, but liquidity exists in the system to the extent of Rs 50,000-Rs 60,000 cr. RBI may want to retain some liquidity in the system in order to carry out the G-Sec auctions process smoothly, but on the flip side it will also not like the liquidity to fan inflation. Thus it would like to get rid of some liquidity from the system.

Conclusion

These are some of the most important considerations that will dictate RBI’s decision. A 25 bps hike in all the rates viz Repo, reverse repo and CRR. It is also expected that it may hike the rate by 50 bps. A 25 bps hike in CRR removes about Rs 12,000 cr of liquidity from the system. Considering this, I think that RBI may hike the CRR by 25 bps only and wait for hiking it by another 25 bps for some time. Regarding, repo and reverse repo rates, with RBI’s mid policy hike in March, it has given strong signal of a tightening stance. It will continue with the same. But at the same time, it will not like to derail the growth process by indulging in aggressive rate hikes. A 50 bps hike after the 25 bps hike in March, may pose threat to the nascent growth prospects. Recent developments have given early signals of a moderating inflation, thus RBI may hike the policy rates by 25 bps only instead of 50 bps and prefer to resort to mid policy hike for any further increases in the rates.

Author name: Praveen Bajaj, MBA (SCMHRD)

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