Money Bol » reserve bank of india

RBI: Rates, Banks and Inflation

Praveen Bajaj — Mon, 19 Sep 2011 12:08:35 +0000

There could not have been a more opportune time for me to write this article. With every passing day since the last year, Dr Subbarao’s job is getting increasingly tougher. With inflation still keeping up against RBI and absence of significant structural actions on Government’s part to control inflation, options for policy actions with RBI have been reducing. With the whole onus of managing inflation falling on RBI, I think it is apt to rename RBI as suggested in the title of the article.

Here is my take on recent monetary policy review-

Rates

Reserve Bank of India (RBI) continued treading on its rate hike road yet another time. This twelfth rate hike in last 18 months did not come as a surprise especially after inflation, (measured by any index, right now WPI) increased by 9.78% during August compared to 9.22% in the prior month. The repo and the reverse repo rates after the hike stand at 8.25 percent and 7.25 percent respectively while the CRR (cash reserve ratio) and the SLR (statutory liquidity ratio) rates stand unchanged at 6 percent and 24 percent respectively. There were muted expectations in the markets that policy rates might be kept at the same levels while SLR or CRR ratios might be altered. In my opinion, these ratios are used for different purposes.(Read about different policy rates and purposes) With liquidity conditions mostly in shape, barring last week when borrowing on Repo window increased to even around Rs 1,00,000 crore due to advance tax payment, RBI is unlikely to tinker with CRR or SLR atleast in the current scenario.

Banks

Commercial banks are likely to see deterioration in the NIMs. RBI has been stressing on the need to increase the deposits growth and going easy with credit growth. While credit growth has moderated to around 20% in August’11 compared to 21% in March this year, moderation is not substantial. Deposit growth still trails at 18% presently compared to 16% in March. As indicated by SBI, this increase in costs will be passed on to borrowers in a short time. With receding demand, I don’t see a lot of takers at higher rates level. Deposit rates might also see an upward revision simultaneously to stimulate the deposit growth. This, in all probabilities is likely to eat up a portion of banks’ NIMs.

Inflation

On inflation front, RBI has continued with its tough stance (RBI Statement) against inflation. However, the guidance given on inflation this time has been more optimistic than last time. In its Policy review statement, RBI has mentioned its expectations regarding softening of inflation-

“As monetary policy operates with a lag, the cumulative impact of policy actions should now be increasingly felt in further moderation in demand and reversal of the inflation trajectory towards the later part of 2011-12”
“Inflationary pressures are expected to ease towards the later part of 2011-12. Stabilisation of energy prices and moderating domestic demand should facilitate this process”
Views on normal monsoon and a record production of grains “Monsoon rains so far have been normal. The first advance estimates for the 2011-12 kharif season point to a record production of rice, oilseeds and cotton, while the output of pulses may decline”. This might be taken as an expectation that food prices might decrease

However, it also expects that for the coming few months, inflation will remain high. It also gives certain factors which are likely to continue adding to inflationary pressures – “….there is still an element of suppressed inflation. Though global oil prices have moderated, the pass-through to domestic prices remains incomplete. Also, current administered electricity prices are yet to reflect increase in input prices, even as many states have initiated increases. Food inflation is at near-double digit levels, despite normal monsoons, underlining the fact that it is being driven by structural demand-supply imbalances and cannot be dismissed as a temporary phenomenon. The inflation momentum, reflected in the de-seasonalised sequential monthly data, persists”.

My Take

With growth scenario slowly also sluggish, many analysts have started expecting a pause in the rate hiking spree. Global outlook has only worsened in the recent months. Exports are unlikely to continue with the current momentum due to this. On domestic front, IIP growth has been moderating with extreme volatility. This has led Central Bank to indicate that there are downside risks to 8% growth projection in the July review.

I will take it more as an indication from RBI that the rate setting committee is prepared to see the current high levels of inflation for coming couple of months and expect it to start moderating from atleast the last quarter of the current fiscal. Stance of monetary policy has been kept unchanged clearly to keep inflationary expectations at bay. Further rate hikes cannot be ruled out but I feel that the same will be taken only if inflation figures increase beyond this point. Base effect will be pretty high from this point onwards especially during December and January due to over 130 bps Month on month increase during these months in the last fiscal. This atleast on the face will keep inflation figures under control and induce a wait and watch approach of RBI.

Author: Praveen Bajaj

India Inflation : WPI March 2010

Praveen Bajaj — Fri, 16 Apr 2010 19:11:54 +0000

The WPI for the month of January stood at 9.90% against 1.20% in the corresponding month of the last year. The same figure posted 9.89% in the previous month. The figure released was below market expectationswhich was pegged at around 10.37%
The figure registered increased at the fastest pace in 17 months, driven by higher food and fuel prices. The market was hardly moved by the figure and continued falling instead of rising as the inflation figure posted was below expectation.
Acc. to the Finance Minister Pranab Mukherjee, the numbers were on expected terms as they were expecting a double-digit figure. The RBI had already raised the interest-rates to curb the inflation and is expected to do so once again in the monetary policy in April’10.

Inflation Internals

The sub-group of primary articles rose by 14.10% y-o-y against 5.21% in Mar’09.It surged high due to jump in the food articles inflation by 16.65% on a yoy basis but it declined by 0.5% on a mom basis due to lower prices of cereals, fish-inland fruits & vegetables and tea. However, prices of stuffs like poultry chicken, pork, milk, jowar, barley and coffee moved up.
In the same sub-group, the non-food articles decreased by 0.82% m-o-m but increased 12.77% on a yoy basis. The monthly decline was because of lower prices of vegetable seeds, soybean, copra, raw silk and tobacco. The index for minerals rose by 9.79% y-o-y which was due to higher prices of barites, steatite, chromite iron-ore and asbestos
The second sub-group of fuel, power, lights and lubricants increased by 6.9% y-o-y from -6.0% in Mar’10. It registered a growth of 0.28% m-o-m due to higher prices of petrol, light diesel oil, aviation turbine fuel and furnace oil
The third sub-group of manufactured products registered an increase of 7.13% y-o-y from 2.29% in Mar’10. It registered a growth of 0.28% m-o-m mainly because of huge increase in the prices of food-products, sugar and rubber & plastic products. Prices of commodities like cotton textiles, man-made textiles and chemical products too moved in upward direction while wood products, paper products declined.
Food products declined by 1.15% m-o-m due to decline in the prices of edible food products. Sugar declined by 3.73% while there was a decrease of 0.96% in edible oils. Man-made textiles surged by 0.4% due to increase in the yarn and fibre prices Iron & steel decelerated by 0.31% m-o-m

I believe that the current WPI levels are way beyond the comfort zone of the Reserve Bank of India and a hike in the key rates (repo rate, reverse repo rate) in the April 20 monetary policy review is almost certain. This is also because of the fact that the growth in IIP and the profitability of India Inc. is also back on track, thus leaves ample room for RBI to hike the key rates by at least 50 bps without hindering the growth process.

Author name:Rahul Sonthalia, Research Head, Kredent

RBI Raises Repo, Reverse Repo Rates

Praveen Bajaj — Tue, 23 Mar 2010 07:19:58 +0000

Before getting into the details, let us first understand -

What is Repo Rate?

Definition of Repo Rate: Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which commercial banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.

What is Reverse Repo Rate?

Definition of Reverse Repo Rate: It is the rate at which Reserve Bank of India (RBI) borrows money from banks. Banks are always happy to lend money to RBI since their money are in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this attractive interest rates. It can cause the money to be drawn out of the banking system.

In order to tame inflation, anchoring inflationary expectations and considering the signs of strong economic revival RBI on March 19 , 2010 announced Monetary Policy Measures with immediate effects:

to raise the repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 4.75 % to 5 %
to raise the reverse repo rate under the LAF by 25 basis points from 3.25% to 3.5%

This is the second action since January when RBI announced a 75-basis point rise in the cash reserve ratio (CRR) to 5.75 per cent. But, unlike CRR, which is used to manage liquidity in the system, an increase in the repo and reserve repo rates is aimed at signaling an increase in interest rates.

The action by RBI is the first increase in policy rates since July 2008 when the repo rate was increased 50 basis points. The reverse repo was last raised in July 2006, when RBI raised the rate 25 basis points. Since October, 2008, RBI started the process to reduce interest rates and lowered the CRR to inject liquidity in the system to spur economic activity in the wake of the global downturn. These steps of RBI comes against the backdrop of rising inflation which touched 9.89 per cent in February YoY basis which has exceeded the base line projection of 8.5% for end march 2010 set out in the third quarter review and RBI for the first time said that wholesale price index-based inflation may cross double digits in March 2010.

As per RBI as liquidity in the banking system will remain adequate, credit expansion for sustaining the recovery will not be affected and the RBI will continue to monitor macroeconomic conditions, particularly the price situation, and take further action as warranted.

Impact:
The overall interest rate of banks on advances (like housing loans, consumer loans, auto loans etc) will go up. It is not expected to have a major impact on corporate borrowings in the immediate future. Yield on government securities, which eased to 7.82 per cent, from a 17-month high of 8.02 per cent last week, could harden in the days ahead.

Author: Abhijeet Ahir, Economic Analyst, MBA Finance (SIIB)

Monetary Policy and Credit Policy

Praveen Bajaj — Wed, 28 Oct 2009 06:38:00 +0000

The Reserve Bank of India announced its second quarter review of monetary/credit policy. Despite the fact that most of the key rates policy rates remained unchanged as expect, the benchmark indices corrected by around 2% with the banking and real estate sectors plummeting the most. This is mainly because of the fact that the policy sets a tone for the beginning of the reversal of Monetary Easing.

Some of the key highlights form the policy documents are:

The share of agriculture in GDP has been declining over time, and as of 2008-09 it was 17.0 per cent. However, experience shows that a deficient rainfall can have a disproportionate impact on overall economic prospects and on the sense of well-being. Poor output will push up prices and depress rural labor incomes. Given the inter-sectoral supply-demand linkages, the knock-on impact on the industrial and services sectors can also be significant.
Continuing the trend witnessed since Q2 of 2008-09, the two major components of demand, viz., private final consumption expenditure and gross fixed capital formation (with a combined weight of around 88 per cent) decelerated further in Q1 of 2009-10. Government consumption, which had increased sharply in Q3 and Q4 of 2008-09 due to the fiscal stimulus measures and the Sixth Pay Commission payouts, also decelerated in Q1 of 2009-10. While the direct impact of fiscal stimulus is waning, its indirect impact on private consumption and investment will persist for some more time
The GDP projection for 2009-10 for policy purposes remains unaltered at 6%, made in the First Quarter Review of July 2009.

Keeping in view the global trend in commodity prices and the domestic demand-supply balance, the baseline projection for WPI inflation at end-March 2010 is placed at 6.5 per cent with an upside bias. This is higher than the 5.0 per cent WPI inflation projected in the First Quarter Review of July 2009 as the upside risks have materialized

The policy dilemma for India is different in some important respects from that of advanced economies as also other emerging market economies. First, most of these countries do not face an immediate risk of inflation. Indeed, in several advanced economies, the concerns were about a possible deflation, which are just about waning. On the other hand, India is actively confronted with an upturn in inflation – a rising WPI inflation and stubbornly elevated CPI inflation
An issue of some immediate relevance is the critical need to downsize the government borrowing programme so as to help sustain a moderate interest rate regime. This is crucial for investment demand to pick up on which hinge our long-term economic prospects
Reversing monetary policy easing stems from the concern about inflation. WPI inflation has turned positive, the base effect which has kept WPI low so far is now gone and CPI inflation has remained stubbornly elevated. On a financial year basis, WPI has already increased by 5.95 per cent. In as much as monetary policy acts with a lag, there is need to act now
The Reserve Bank’s inflation expectations survey shows that households expect inflation to increase over the next three months as also one year. The lag with which monetary policy operates suggests that there is a case for tightening sooner rather than late

The balance of judgment at the current juncture is that it may be appropriate to sequence the ‘exit’ in a calibrated way so that while the recovery process is not hampered, inflation expectations remain anchored.

The ‘exit’ process can begin with the closure of some special liquidity support measures. In this policy government has indeed removed some special liquidity support measures like:

The statutory liquidity ratio (SLR), which was reduced from 25 per cent of demand and time liabilities to 24 per cent, is being restored to 25 per cent
The limit for export credit refinance facility [(under section 17(3A) of the RBI Act], which was raised to 50 per cent of eligible outstanding export credit, is being returned to the pre-crisis level of 15%
The two non-standard refinance facilities: (i) special refinance facility for scheduled commercial banks under section 17(3B) of the RBI Act (available up to March 31, 2010), and (ii) special term repo facility for scheduled commercial banks (for funding to MFs, NBFCs, and HFCs) (available up to March 31, 2010) are being discontinued with immediate effect

In view of large increase in credit to the commercial real estate sector over the last one year and the extent of restructured advances in this sector, it would be prudent to build cushion against likely non-performing assets (NPAs). Accordingly, it is proposed that to increase the provisioning requirement for advances to the commercial real estate sector classified as ‘standard assets’ from the present level of 0.40 per cent to 1 per cent

Our Analysis:

It is quite evident from the mentioned facts in the credit policy that the central bank will in any circumstances curtain the rise in inflation and on the basis of the overall assessment the first priority among the stance of monetary policy for the remaining period of 2009-10 is to “Keep a vigil on the trends in inflation and be prepared to respond swiftly and effectively through policy adjustments to stabilize inflation expectations.”

Thus we strongly believe that a rate hike is definitely on the cards in third quarter monetary policy for FY2009-10 and hence as already mentioned in the report titled “Credit Policy Eve” one should start booking profits from the rate sensitive sectors like banking, real estate and infrastructure and start moving towards defensive sectors.

Author: Rahul Sonthalia, Analyst, Kredent Group