| Reactions to the monetary policy |
| BS Reporter / Mumbai July 28, 2010, 0:58 IST |
In its quarterly review on Tuesday, the Reserve Bank of India (RBI) lifted the repo rate by 25 basis points to 5.75 per cent and raised the reverse repo rate by 50 basis points to 4.5 per cent, more than the 25 basis point increase economists had expected. Meanwhile, CRR remains unchanged at 6 per cent.
Following are reactions to the policy:
Gagan Banga
CEO, Indiabulls Financial Services
"The monetary policy announced by RBI today was in line with our expectations of a 25 bps rise in the repo rate. The hike in the key rates should help soften inflation which has been in double digits since February 2010. We expect the short term interest rates to remain high, yield curve to flatten and mortgage rates to remain stable in near term."
Devendra Kumar Pant
Director, Fitch Ratings India
"RBI's first quarter review of monetary policy was presented against a backdrop of strong domestic economy; high inflation rate, particularly food inflation, which is now transmitted to other sector of the economy and threatening to go out of hand; and fragile global recovery, especially in Europe. There are clear indications of demand pressure on the economy; non-food manufacturing inflation has increase to more than 7% in June 2010. This is likely to increase further, once the indirect impact of petroleum products price rise starts reflecting on wholesale prices.
"As expected the RBI has increased repo rate by 25 basis points, reverse repo rate by 50 basis points and left CRR unchanged at 6.0% of net demand and time liabilities. These policy measures are broadly on expected lines. There was unanimity on 25 basis points increase in repo and reverse repo rates. Interest rates in the economy are certainly going to increase. A further monetary tightening is not entirely ruled out. Extent of tightening would depend on inflation trajectory."
Ramanathan K
CIO (Single Manager), ING Investment Management India
“The increase in reverse repo rate by 50 bps was above market expectation. Clearly the policy focus has shifted to addressing demand side pressures and containing inflation. The narrowing of the LAF corridor would also help maintain the LAF rates in a narrower corridor and help in effective transmission of the tightening bias under easy liquidity conditions. Given the recent frequent inter-policy rate actions and the need for a faster calibrated exit, the RBI has also instituted a mid quarter review of monetary policy which would reduce the negative surprise element of such inter-meeting policy actions.”
Uday Phadke
President (Finance, Legal & Financial Services Sector) Mahindra & Mahindra
"The policy is on expected lines and aims at a balanced growth. While trying to tackle the demand side inflation through Policy Rate Action, RBI has ensured that liquidity is reasonably maintained and interest rate hikes are calibrated. RBI’s estimates of higher growth at 8.5% and year end inflation of 6% would probably imply that if inflation is in line with this expectation and growth is on course, further interest rate hikes would only be in exceptional circumstances."
Bipin Kabra
CFO, Dhanlaxmi Bank
"Very clearly, the objective of controlling inflation and anchoring inflationary expectations, without destabilizing growth impulses, continues to remain the centrepiece of the central bank’s policy framework. When viewed in conjunction with the current liquidity tightness, the policy objectives seem pellucid.
The increase in repo rate by 25 basis points to 5.75% was expected by the market and is correctly aimed at squelching inflation and inflationary expectations in the system. But, the increase in the reverse repo rate by 50 bps to 4.5% is aimed at narrowing the corridor between the two rates and to ensure that call rates do not fluctuate too wildly, which could then lead to rate instability and volatility.
In a sense, this seems to presage continuing liquidity tightness, notwithstanding the Rs 32,000 crore repayment of G-Secs expected tomorrow (Wednesday, July 28).
The central bank expects the growth impulse in the economy to be strong and has therefore decided to increase the GDP growth projection to 8.5% from the earlier 8% with an upwards bias. However, risks continue to dog the economy, emanating from the fragile growth in the developed economies and the uncertainty over the final coverage of the monsoons. The projection for WPI in March 2011 has now been raised to 6% from 5.5% earlier. Hence, the battle to lower inflation and anchor inflationary expectations is likely to form the central theme of future policy documents."
Romesh Sobti
MD & CEO, IndusInd Bank
"A forward looking decision to address demand side inflationary pressures.
The delivery of 0.5% hike in Reverse Repo rate and 0.25% hike in the Repo was indeed a master stroke. The majority of the market participants were in favour of a 0.25% hike in both policy rates but some were voicing the need to hike Reverse Repo rate by 0.5% to keep the shorter end of the yield curve up as and when Reverse Repo becomes operative. RBI Governor chose to mix both expectations which came as a surprise to all participants.
The decision has a mix of popular and prudent approach with intention to manage demand side inflationary pressures till emergence of signs of reversal expected in the second half of current financial year. The stance of RBI seems to be negative on inflation and neutral on growth momentum, hence the priority to address inflationary pressures ahead of growth concerns. The uncertainty however is on liquidity and the timing of call money moving into LAF corridor to shift the operating rate to Reverse Repo. RBI cannot afford to stay as a lender for extended period of time after impounding 31% of Bank's NDTL. The signal for quick reversal into LAF corridor is given through the hike in Reverse Repo Rate to bring the element of logic for the need to hike Reverse Repo Rate.
Over all, the surprise was not a harsh one but gives the signal that call money rate would move into 4.5-5.0% sooner than later to dilute the impact from rate hike actions with 10Y bench mark yield steady at 7.60-7.75%. It is a welcome decision both for policy makers and various stake holders of the economy."
Abizer Diwanji
Head of Financial Services, KPMG in India
The credit policy is in line with the issues identified in the monetary policy. RBI has listed 3 broad objectives going forward first containing inflation, second maintaining interest rates within a range and third actively managing liquidity. while the three are inter related let's analyse how these have been dealt with in the credit policy Given that M3 growth is at 15.2% against a credit growth of 22%, there is an element of demand side inflation in the system. To stem that, RBI has incentivized banks by increasing reverse repo rates by 50 bps. This would result in lower credit outflow to a projected 20% and increase M3 to 17% by fiscal year end.
On the liquidity and interest rate front, a lot has been done to moderate short and long term rates. On the shorter end, the special LAF has been extended to 31 July and also the repo rate has been increased but only by 25 bps. In addition the Treasury bill issuance has been reduced by Rs 22,000 crore to ensure liquidity position remains stable and interest rates contained. while on the shorter end, liquidity has been eased (was tight mainly due to Rs 1,06,000 crore against Rs 35,000 crore being suck out for telecom licenses), the longer term perception of stable govt finances and hence, not needing to issue 10 year paper have driven down to 7.73% from 8%.
In all, short term money has been restrained from an interest rate and deployment perspective while long term rates have been stabilised with strong govt finances and approx 62% of budgeted borrowings to go before year end.
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Shriram Ramanathan
Portfolio Manager – Fixed Income
Fidelity Mutual Fund
"Probably, the more significant change arising from the policy has been the implicit shift in the ‘operative’ rate to the repo rate (upper end of the corridor) and RBI’s intent to actively manage liquidity and ensure that it does not move into a surplus. As a result, the 150bps rise in overnight interest rates seen over the past couple of months - on account of one-off telecom flows to the government - may not be temporary and could be here to stay. The overall tone of the policy is somewhat more hawkish than expected. The short end of the yield curve is likely to stay elevated given that the days of surplus liquidity in the system are unlikely to come back again in the near to medium term. However, with RBI action becoming more decisive, increased market faith in RBI’s ability to deal with inflation is likely to provide medium term support to the longer end of the yield curve."
Naresh Takkar
Managing Director, ICRA
In conjunction with the sustained and strengthening domestic economic recovery and improved prospects of Indian economic growth in the ongoing fiscal, concerns raised by the persistently high wholesale and consumer price inflation rates have moved on to the forefront. The RBI has articulated a clear shift in its policy stance “to containing inflation and anchoring inflationary expectations” and moderating inflation by reining in demand pressures and inflationary expectations. The RBI’s current policy action has tried to address the inflationary expectations through a repo rate hike, and reduced the width of the interest rate corridor so as to manage short-term interest rate volatility better. The RBI has refrained from effecting any CRR hike to ensure adequate funds for the economy, which is expected to grow at a faster pace.
While the increase in the repo rate may push up interest rates in general, such an increase may not slow down the pace of corporate investments, given that the likely increase in domestic demand would also improve corporate capacity to absorb increases in interest costs. The repo rate on its part is likely to remain the operative rate in the light of the expected tightness in liquidity, given the strong demand for funds from the commercial sector, large government borrowings, and the relatively low rate of growth in deposits.
As for the inflation trajectory, this would be influenced largely by domestic demand, the performance of the monsoons and the behaviour of fuel prices. However, the demand for funds from the commercial sector is likely to remain high, considering the high growth potential of the economy. Therefore, the RBI would have to do a tightrope walk during the rest of the year managing inflationary expectations and ensuring adequate liquidity at reasonable cost for future capacity creation.
We welcome the RBI's decision to undertake mid-quarter reviews as this reduces the need for ad hoc measures.
Madan Menon
Head of GBM- India, RBS
The RBI’s latest policy action is in line with RBS house view (as expressed on release of customer survey –RBI #3 last Thursday) but more aggressive than what had been widely anticipated by the market. We expect RBI to raise the reverse repo by 50 bps and the repo by 25 bps on the next meeting narrowing the LAF corridor to 100 bps by the end of the year While it appears that the central bank has gone a little ahead of the calibrated pace of policy tightening it has followed until this week, its action is still very much consistent with the need to curb wide spread inflationary pressures. Reflecting its inflation concerns, the RBI has raised its end-March WPI inflation forecast to 6% from a previous forecast of 5.5%. It says inflationary pressures have become generalized and demand side pressures are clearly evident as an economic recovery is firmly in place. It acknowledges the better growth environment by raising its GDP growth forecast to 8.5%.
The central bank has noted that while most of the counter inflationary pressures are emerging from global conditions of stable global commodity prices and excess industrial capacity, domestic demand conditions would continue to push inflation. The headline WPI inflation figure may not ease below 6.5% in this fiscal year. In narrowing the LAF rate corridor to 1.25% from 1.50%, the RBI has ensured that the short-end rates remain anchored around a higher rate even when liquidity conditions go back to surplus. This move will have limited impact now considering that the operational rate at the moment is the repo rate. We expect the RBI to further tighten policy rates by another 50 to 75 basis points this fiscal year. In RBI’s opinion there is significant risk of slowdown of capital inflows, which could negatively affect the investment momentum and rupee’s value. In the central bank’s assessment slower global growth and increasing investor risk aversion may reduce capital inflows into India and other emerging markets, significantly. This is particularly important as this reflects a departure from the RBI’s expectations of strong capital inflows this year.
Slower inflow of capital along with widening trade deficit, would mean that the rupee could remain weak for some time. While the medium-term rupee appreciation potential is well in place, the short-term prospects of the rupee remain weak. The second half of the fiscal year sees better inflows from sources such as FDI and dollar flows from invisible flows such as NRI remittances also tend to pick up then. Any improvement in the value of the rupee looks possible only towards the end of this calendar year.
The RBI's decision to review its policy every six weeks instead of once a quarter is welcomed. This would facilitate banks in their review and adjustment of their loan and deposit pricing more in line with macro-economic conditions.
Ashvin Parekh
National Leader, Global Financial Services, Ernst & Young
In its first quarter FY2011 review of the monetary policy the Central Bank was largely expected to raise the policy rates. The hardening of interest rates with repo rate being hiked by 25 basis points and reverse repo by 50 basis points signals stronger measures by RBI to control the rising inflation notwithstanding the tighter liquidity conditions. Inflation which started as a supply side bottleneck has become more generalized moving beyond mere food inflation. Even as the inflation remains high the demand side pressure on it are building up. The supply side factors are expected to ease depending on the monsoon (14% deficient on average) and growth in agricultural output.
The RBI has increased its GDP forecast for FY11 from 8.0% to 8.5% signaling a robust domestic economic performance. This increase will be driven by revival of domestic demand and growth in exports which has been positive since October ’09 despite the concerns over global economy. The demand drivers are expected to be robust with the expected good monsoon and revival of rural demand.
The credit growth of banks accelerated to 22.50% in June from 16.9% in March which was expected following the strong IIP and GDP numbers for FY10. The tight liquidity conditions manifested in the rising overnight call money rates which increased from 3.85% in May to 5.07% in June. However it is expected to remain within manageable bounds with the expected flow back of the 3G license funds even with the larger than expected hike of 50 bps in the reverse repo rate.
The rate hikes will in all probability be passed on to the consumers as the banks had absorbed the last round of hikes on 2nd July, also in the base rate regime the transmission will be faster affecting the cost of funds of the banks and in turn the cost to the consumer.
Going forward the central bank has indicated a stronger stance on managing inflation with hardening of interest rates. While this might not have an immediate dampening effect on the economic growth, if inflation doesn’t moderate in the next couple of months, we might even see a slight downturn in GDP in the third and fourth quarter of fiscal FY11.
Significant announcements were also expected from the central bank on the new banking licenses, bank holding company structures and presence of foreign banks, which we might see in following couple of weeks.
Deepali Bhargava
Economist, ING Vysya Bank
There’s a clear shift in RBI’s policy priority towards “containing” inflation, which seems to be the ‘dominant concern’. Inflationary pressures have assumed utmost importance also as RBI recognises that the growth recovery has ‘consolidated’ and is increasingly becoming broad-based.
Taking into account the surge in non-food inflation to 10.6% in June 2010 (from near zero in November 2009), rising capacity constraints and continued build-up in demand-side pressures, RBI has raised its baseline projection for WPI inflation for March 2011 from 5.5% to 6%, slightly below our expectations of 6.3%. With respect to prospects of softening inflation, RBI feels that it would be contingent on moderation in food prices and global scenario which may generate some favourable impulses. RBI aims to contain the perception of inflation in the 4-4.5% range, which we feel may be a challenge given a structural shift in inflation Break-up of credit growth also suggests an improvement in sectoral distribution. YoY growth in personal loans’ credit has returned back to the positive territory in May 2010 with the share in total credit disbursement at around 7% during Nov’09-May’10 (up from 1.5% in the year prior). Though ‘industry’ continues to receive the bulk of bank credit, share of services too has gone up to 26.5% in the quarter ending May’10 from 22% in the quarter prior. Current credit growth at 22.3% YoY (higher than RBI’s indicative projection of 20% YoY) has also instilled confidence of a firm growth recovery.
Narrowing of Repo-Reverse Repo corridor to 125 bps, down from 150 bps earlier, implies that RBI sees increased volatility in liquidity, going forward. This is in line with our expectations. We have been long highlighting that the times of easy liquidity are li
