Analysis on the RBI’s monetary policy for 2009-10

The Reserve Bank of India (RBI) left its key policy rates unchanged in its first quarterly review of monetary policy for 2009-10 on July 28th. The repo rate – the rate at which banks borrow money from the RBI – was left unchanged at 4.75%, the reverse repo rate – the rate at which banks lend funds to the RBI – remained at 3.25% and the Cash Reserve Ratio (CRR) - the percentage of deposits that banks keep with the central bank was kept unchanged at 5%. The decision, however, didn’t surprise the market at all for its obviousness. The RBI had reduced the repo rate six times, amounting 425 basis points since Oct’08 in order to ensure enough liquidity in the system. As the liquidity situation has been quite comfortable for last 5-6 months and the inflation seems to be posing a threat in the second half of the current fiscal year, RBI’s decision of maintaining a status quo is completely plausible.

* With upward bias, ** end March

Growth outlook:
The RBI looked more sanguine about the domestic growth outlook yesterday than the last policy review in Apr’09. According the policy document, the business outlook in the country has turned positive signaling a revival of industrial activity. However, the RBI expects the export demand to continue to remain weak in coming months and the services sector may experience the drag of sluggish external demand and the lagged adverse impact of the weak industrial growth. Also, the below normal monsoon this year is likely to pull down the agriculture production for the Kharif season crop. Weighing all these factors, the RBI’s the growth projection for GDP for 2009-10 is placed at ‘6% with an upward bias’. I fee the RBI has been a tad conservative about the GDP forecast. As the recent macro-data points to a better economic environment, the economy is likely to grow at 6.5% in 2009-10.

Inflation outlook:
On inflation front, RBI expects the annual inflation to go up to 5% by the end of March 2010. It says that the WPI-based inflation, which has slipped below zero, has only statistical significance and doesn’t reflect a contraction in demand and may not persist beyond a few more months. However, it expressed concern about the elevated food inflation and an uncertain monsoon outlook could further accentuate the problem.

Regarding the money supply growth, the RBI projects the M3 money supply to grow at 18% during 2009-10. Furthermore, the bank deposit and the bank credit are projected to be growing at 19% and 20% respectively in 2009-10.

But I see the RBI will be having a bigger responsibility this time. As the fiscal deficit has been estimated at 6.8% of the GDP in 2009-10, the government plans to withdraw Rs 4.5 trn from the market in the current financial year. This has hardened the interest rate in the bond market. At the same time the RBI will have to ensure that there is enough liquidity left in the system so that the private sector also has easy access to the funds. But if the government goes little aggressive on the disinvestment plans, the situation could improve significantly with foreign money flowing into the economy.

Outlook for Rupee:
The RBI’s decision of keeping the policy rates unchanged doesn’t seem to have much impact on the rupee. However, a revival in FII inflows and an improved domestic growth outlook are likely to provide a support to the rupee in the coming months. Risk aversion is also expected to subside on possible global economic recovery towards the end of 2009. Therefore, I expect the rupee to inch towards 46.50-47 levels by end of Mar 2010. In the immediate term, however, rupee could continue taking cues from the direction of domestic equity markets and from the dollar’s movement against other major currencies.

To sum up the whole thing, I would like to add that the nine-month long easing cycle of the interest rate seems to have come to an end and the RBI’s next move will be to increase the key rates which might happen as soon as beginning of 2010.

Slowdown in credit off-take in India

Credit off-take has been rapidly slowing down in India since June’08, mainly because of high interest rates (until Oct’08) and banks unwillingness to lend later on. Though the RBI – the central bank of India - has projected 20% growth in the credit off-take for the fiscal year 2009-10, credit growth has slowed down to merely 16.7% in the first quarter of FY10, down from 25% in the same period last year.

But there is some positive news which has come up today regarding the credit off-take in India. The total credit off-take increased 16.3% (y/y) as of 3rd July’09, higher than the 15.1% in the previous fortnight. However, it’s still far below the peak of nearly 30% in Oct’08. But a high base effect is also playing its role in distorting these numbers. Not a problem. Let’s take a look at the monthly growth rates, which could give more insights in the current situation.
Banks' credit growth rate in India

Source: Nomura, CEIC

Well, looking at the monthly growth rates, credit growth seems to be gradually gaining traction; credit growth rose to 1.2% (m/m, s.a.) in June’09, as compared to 0.3% in the beginning of 2009.
Banks have become very reluctant to lend money post Lehman Brothers collapse. They rather prefer putting money with the RBI. There has been excess liquidity in the system for last seven months now, which can be seen by repo liquidity data (see the graph below).

To stop that, the RBI has reduced the reverse repo rate – the interest money banks get for parking their funds with RBI – to 3.25% in April’09, from 6% last year. But the result is yet to be seen. The RBI should take some steps to ensure easy access to funds if it wants to see the country growing at a higher pace. The central bank is going to decide on its interest rate on July 28. Till then, take a chill pill and start snoring.

India Budget 2009-10 spoils the party

I am not enjoying writing this post. Why? Actually, I along with millions of Indian citizens was expecting so much from this budget . Alas ! it fails to deliver completely. That's why I didn't feel like writing about it. But we can't ignore it either. First have a look at the highlights and my comments.

Highlights of the budget

(Fiscal year: April 1 – March 31)

§ Real GDP growth assumed at 6.5% in fiscal year 2009-10 – Quite realistic

§ Fiscal deficit projected at 6.8 % of GDP – No roadmap for fiscal consolidation

§ Total expenditure increased by 36 % to Rs 10,208.38 bn over 2008-09 – Govt will have to borrow from markets, leading to upward pressure on interest rates

§ Allocation for the National Highway Development Programme (NHDP) increased 23% in 2009-10. Also, allocation for Bharat Nirman increased 45% in 2009-10 - Infrastructure gets a focus

§ Allocation under National Rural Employment Guarantee Scheme (NREGS) increased by 144 % to Rs 391 bn in 2009-10 – NREGS has been quite successful in the past and will provide further support to the poor

§ Unique Identification Authority of India (UIDAI) to set up online data base for Indian residents and provision of Rs 1.2 bn made for this in the budget – a welcome step

§ No change in corporate tax rate – No relief to corporate India

§ Fringe benefit tax (FBT) to be abolished – Will provide immense relief to millions of people

§ Commodity transaction tax (CTT) to be removed

§ Minimum alternate tax (MAT) to be increased from 10% to 15% of book profits

§ Raised the exemption limit of personal income tax by Rs 10,000 for all categories of individual taxpayers; by Rs 15,000 for senior citizens. Also, surcharge of 10% eliminated on personal income tax – people will have more money to spend

Finance minister Mr. Pranab Mukherjee disappointed the country by presenting a very ordinary (or call it hopeless) budget on July 6. The whole country was waiting for this event desperately; more so because the Congress had received a renewed mandate following the general election in May09. The newly elected government was expected to bring some revolutionary reforms to set the country on a higher growth trajectory. Nothing of this sort happened. On the contrary, there was no clear road-map on how the government is going to tackle the high fiscal deficit, which has been projected at 6.8% of GDP in FY10. Here are the key numbers from the budget.

But don’t get too disheartened. Budget is not the only platform to declare all the reformatory actions. The government might declare some more actions whenever it gets ready for them. Think positive!!

A silver lining in the cloud!

Indian exports continue to be on a falling spree. Exports declined 29.2% (y/y) in May’09 to $11 bn, after dropping 33.2% in Apr’09 due to weak global demand. This was the eighth straight month when exports have fallen sharply.

The Rupee is likely to appreciate in the coming months (see my previous post on rupee), which in turn will make exports less competitive in the international markets. Therefore, the road from here is not going to be smooth for the exporters. However, the government may unveil relief measures in the coming budget on July 6 to help exporters survive. There are expectations that the government may announce a foreign trade policy in Aug’09 to provide further support to the exporters.

Well, this is not all too bad. There is a silver lining here. Indian imports are also falling continuously for past six months at the same time. Imports fell 39.2% (y/y) in May’09 to $16.2 bn, following 36.6% drop in Apr’09. As a result, India’s trade deficit has halved to $5.2 bn in May’09, as compared to $11.2 bn a year ago. A shrinking trade deficit comes as good news for the economy. Don't you think so?