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India – Back to tightening mode
The RBI predictably raised its policy repo and reverse repo rates by 25bps to 6.5% and
5.5%, respectively. More important was the shift in the tone of the policy statement to a
decidedly more hawkish one. In fact, the new stance of the RBI can be gauged from the
following excerpt: Current growth and inflation trends warrant persistence with the antiinflationary
stance.
Details: Specifically, the RBI has acknowledged that inflationary pressures have re-emerged
in a significant manner since its review in November. Food prices have rebounded after a
brief moderation with the underlying problem stretching beyond temporary supply side
shocks. With energy prices also remaining at elevated levels, the risk of supply side
pressures spilling into broader inflation is high. The risk is being accentuated by strong
demand conditions as evident from accelerating bank credit and corporate sales. The RBI
has also cited intensified wage pressures both in the corporate and rural sectors. Therefore,
there is a need to persist with measures to contain inflation and anchor inflationary
expectations.
Another related concern that the RBI has raised is with the direction of credit and loans. At
24% yoy, credit growth has not only breached the official target of 20% but is well ahead of
deposit growth. Consequently, the central bank has suggested that banks need to address
the structural cause of this divergence between credit and deposits. We read it as a
suggestion to raise deposit rates more aggressively. It did however acknowledge a better
transmission from policy rates through to deposit rates.
The RBI has also expressed concern with the rising current account deficit. Although monthly
customs cleared trade data suggests that the current account gap may have moderated from
its peak level of 4.1% of GDP in the July-September 2010 quarter, the full year number is still
likely to be high at 3.5% of GDP and susceptible to fuel prices. Indeed, our estimates also
show that a USD10/barrel rise in crude oil prices raise the current account deficit by 0.5% of
GDP. The concern is all the more demanding considering that external funding is largely
portfolio related.
Finally, on the tight liquidity situation in the banking system, the RBI has decided to extend
the second liquidity adjustment facility (LAF) and 1% reduction in the statutory liquidity ratio
until April. Considering its limited effectiveness until now, we do not think that this extension
will make a material difference. Some relief however, may come from reduced pressure from
the fiscal side. The government has completed almost 95% of its borrowing programme until
now. The more relevant influence on bank liquidity will be the extent of increase in deposit
rates. As we have written earlier, deposit growth has been sluggish largely due a shift in
household portfolio preferences away from deposits to inflation hedges such as property and
gold.
Overall, based on the policy statement and the inflation outlook, we believe that the RBI has reopened
the door to further rate hikes. The earlier expectation that the RBI was in its conclusive
stages of tightening has given way to the possibility of a whole new tightening cycle. Based on
our current forecasts, we expect further hikes of 100bps over the next 12 months.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
India – Back to tightening mode
The RBI predictably raised its policy repo and reverse repo rates by 25bps to 6.5% and
5.5%, respectively. More important was the shift in the tone of the policy statement to a
decidedly more hawkish one. In fact, the new stance of the RBI can be gauged from the
following excerpt: Current growth and inflation trends warrant persistence with the antiinflationary
stance.
Details: Specifically, the RBI has acknowledged that inflationary pressures have re-emerged
in a significant manner since its review in November. Food prices have rebounded after a
brief moderation with the underlying problem stretching beyond temporary supply side
shocks. With energy prices also remaining at elevated levels, the risk of supply side
pressures spilling into broader inflation is high. The risk is being accentuated by strong
demand conditions as evident from accelerating bank credit and corporate sales. The RBI
has also cited intensified wage pressures both in the corporate and rural sectors. Therefore,
there is a need to persist with measures to contain inflation and anchor inflationary
expectations.
Another related concern that the RBI has raised is with the direction of credit and loans. At
24% yoy, credit growth has not only breached the official target of 20% but is well ahead of
deposit growth. Consequently, the central bank has suggested that banks need to address
the structural cause of this divergence between credit and deposits. We read it as a
suggestion to raise deposit rates more aggressively. It did however acknowledge a better
transmission from policy rates through to deposit rates.
The RBI has also expressed concern with the rising current account deficit. Although monthly
customs cleared trade data suggests that the current account gap may have moderated from
its peak level of 4.1% of GDP in the July-September 2010 quarter, the full year number is still
likely to be high at 3.5% of GDP and susceptible to fuel prices. Indeed, our estimates also
show that a USD10/barrel rise in crude oil prices raise the current account deficit by 0.5% of
GDP. The concern is all the more demanding considering that external funding is largely
portfolio related.
Finally, on the tight liquidity situation in the banking system, the RBI has decided to extend
the second liquidity adjustment facility (LAF) and 1% reduction in the statutory liquidity ratio
until April. Considering its limited effectiveness until now, we do not think that this extension
will make a material difference. Some relief however, may come from reduced pressure from
the fiscal side. The government has completed almost 95% of its borrowing programme until
now. The more relevant influence on bank liquidity will be the extent of increase in deposit
rates. As we have written earlier, deposit growth has been sluggish largely due a shift in
household portfolio preferences away from deposits to inflation hedges such as property and
gold.
Overall, based on the policy statement and the inflation outlook, we believe that the RBI has reopened
the door to further rate hikes. The earlier expectation that the RBI was in its conclusive
stages of tightening has given way to the possibility of a whole new tightening cycle. Based on
our current forecasts, we expect further hikes of 100bps over the next 12 months.
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