Easing though liquidity route to continue, 100bps cut in repo rate in 2013

Due to high inflation, the RBI today kept the repo and reverse-repo rates unchanged, at 8% and 7% respectively. However, in order to keep liquidity into its comfort zone, RBI cut the cash-reserve ratio (CRR) 25bps, to 4.25% of net demand and time liabilities (NDTL). The move would inject Rs 17,500 cr liquidity into the system. Taking the liquidity route to ease monetary policy, the RBI has cut the CRR by 175bps in last ten months.

The RBI has revised its FY13 GDP forecast downward to 5.8% from 6.5% in Jul ’12 policy. The WPI inflation target for Mar’13 has been revised to 7.5%, from 7% earlier.  Both deposit and non-food credit growth has been revised downward by 100bps to 15% and 16%, respectively.

100bps cut in repo rate in CY13. Given upside risks to inflation till Dec ’12, a rate cut by RBI until Dec’12 is unlikely. I expect the central bank to focus on easing liquidity through open market operations (OMOs) and by slashing cash reserve ratio. I expect WPI inflation to peak out at 8.5% in Dec’12. Likelihood of a bumper rabi crop and strengthening rupee, coupled with a favourable base effect, are key factors which could soften WPI inflation considerably post Dec’12. I expect WPI inflation to soften to 6.1% in Apr’13. Accordingly, I expect 100bps repo rate cut in 2013 with the first cut starting from Feb-Mar ’13. In its guidance, the RBI also said, “the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of 2012-13”. Until then, the RBI is likely to continue with the liquidity enhancing measures – CRR cuts and OMOs – to support growth.

Food prices on fire, I see some actions coming from the RBI

At a time when most economies in the world are reeling under deflationary pressure, India stands isolated with intimidating inflationary pressure. And believe me it’s a very dangerous situation when it comes to food inflation in India. I have actually seen my kitchen bill rising like anything every month. I was shocked to see my kitchen bill in Nov 09; it has swollen by around 75% as compared to Mar 09 figures. This is my own experience with mounting inflation in my country. Let’s see what the government’s estimates talk about inflation.

 Primary articles inflation up. For the week ended 28th Nov ’09, the annual rate of inflation for primary articles stood at 13.9% (yoy) against 12.5% for the previous week and 11.6% during the corresponding week last year.

 Food inflation at a decadal high. Inflation for the primary food surged to 19.1%, the highest level in a decade. Food inflation has reached the same level of Dec ’98 when the then ruling National Democratic Alliance (NDA) had lost power at the centre because of high food prices. Therefore, there will be huge pressure on the current government to tame the mounting inflation.

 What’s the outcome? We expect the government to take some measures to rein in high food inflation. But the irony is that the government does not have many options to control food prices. Even if it opts for imports, it is not going to help because international prices of most of the food items are either higher or at par with the domestic prices. It also can not offer highly subsidized food due to tight fiscal situation. Nonetheless, to avoid the political pressure the government should be seen doing something to tackle the high food prices. Thus, we would not be surprised to see some actions coming from the Reserve Bank of India (RBI) earlier than expected. A hike of 50 bps in the cash reserve ratio (CRR) seems imminent. Moreover, the probability of a hike in the repo/reverse repo in the current fiscal has also increased.

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.