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Economy
Monetary Policy
3QFY11 Credit Policy review: Desperate on inflation, calibrated in action. RBI
remained hawkish in its stance on inflation and hiked repo and reverse repo rates by 25
bps each. There was no change in CRR. The monetary policy stance continues to be
squarely focused on inflation management as RBI increased its end-FY2011E estimate to
7% from 5.5%. RBI remains confident of domestic growth but does sound worried that
the growth might not be broad-based. Rightly, fiscal issues come to the fore in this
document and are thought to be preventing the efficiency of monetary policy actions.
No surprises in terms of policy action; repo and reverse repo rates hiked by 25 bps each
Inflation being the dominant theme of the policy, RBI hiked the repo and reverse repo rates by 25
bps each keeping the CRR and the SLR unchanged. Liquidity support to SCBs under LAF to the
extent of 1% of NDTL was extended to April 8, 2011 from the erstwhile expiry on January 28,
2011. The second LAF will continue to be conducted on a daily basis till April 8. Though consensus
was for a 25 bps hike, the markets had started anticipating a 50 bps hike on the back of a sudden
sharp rise in the Headline WPI number for December. But the RBI chose to tread a calibrated path
and assess the implications of the previous hikes on the growth dynamics. This is important in light
of the slackness shown by the industrial production and expectations that the IIP yoy growth for
December could dip into the negative zone.
Growth not a concern; inflation estimate for end-FY2011E upped to 7%
RBI retained its GDP target for FY2011E at 8.5% with some bias to the upside. In the
Macroeconomic and Monetary Development report (released yesterday), RBI appeared concerned
that manufacturing sector growth is still not broad-based and nearly 73% of the overall growth
comes from the top-5 manufacturing industries. In FY2012E RBI expects growth to come down
slightly on the back of agricultural sector trending lower. On inflation, RBI expects the current
spike in food inflation to be transitory but structural demand-supply mismatches will keep food
inflation high. It notes that non-food manufacturing inflation remains above the medium-term
trend of 4%. RBI expects inflation in 2011 to be a global concern driven by supply constraints and
rising demand as the developed countries start to recover. RBI consequently has revised up the
end-FY2011E estimates by 150 bps to 7%.
CAD and fiscal situation also seen as risks to economic stability
Apart from rising inflationary expectations, CAD and fiscal situation are highlighted as contributing
to the “increased uncertainty about economic stability that consumers and investors will have to
deal with”. RBI estimates CAD/GDP at 3.5% which is not sustainable and RBI expects policy efforts
to diversify exports and bring down CAD. However, even as slower growth can correct CAD, it
also has implications in terms of lowering capital flows and asset prices, thereby probably
aggravating some of the economic risks. This is probably another reason why RBI could be
desisting from aggressively raising policy interest rates. RBI also raises concerns on budgetary
provisions of subsidies which in a rising oil price scenario threaten to derail fiscal consolidation if
the higher prices are not passed through.
We reiterate our call for added 75-100 bps hike in repo and reverse repo rates through FY2012E
We expect RBI to move repo rate to 7.25-7.5% and reverse repo rate to 6.25-6.5% by end-
FY2012E but in calibrated steps of 25 bps each and at the quarterly meetings. Under current
circumstances, we do not envisage the use of CRR as tight liquidity is likely to stay to enable
monetary policy transmission.
RBI raises a pertinent issue: Its battle against inflation will continue to stay futile
without fiscal consolidation
Inflation has undoubtedly emerged as a “dominant concern” for policymakers with risks to
inflation clearly on the upside. We have for long been highlighting the likelihood of Headline
WPI ending closer to 7.0-7.5% by March 2011-end (see our note released on January 14,
2011 ‘December WPI: Inflation combating on in full swing’). RBI has also moved closer to
our estimate as it raised its end-FY2011 Headline WPI projection to 7.0% from earlier
estimate of 5.5%.
The onus of bringing inflation under control to a large extent has fallen on RBI. However,
the central bank alone is unlikely to win the battle against inflation as monetary policy is
rendered ineffective in addressing supply-side price shocks, which have been at the root of
the current bout of domestic inflation. As highlighted by us in our previous reports, the
uptrend in domestic inflation is largely a result of structural imbalances in several food items
such as milk, eggs, meat etc. Moreover, transitory supply shocks as seen in the case of
vegetables such as onions and tomatoes as also fuel price increases have further added to
the inflationary pressures. Additionally, the surging global food and commodity prices have
further exacerbated the domestic inflation outlook.
RBI has clearly recognized its limitation in addressing the price pressures emanating from the
above factors. In fact, in the policy document RBI indicates the “need for rapid action to
increase the output of a number of products, the demand for which is being driven by
changing consumption patters reflecting increasing incomes.” Unless the supply-side factors
are addressed, food inflation could become entrenched, thereby threatening growth
sustainability.
Additionally, RBI stresses that “monetary policy works most efficiently while dealing with an
inflationary situation when the fiscal situation is under control”, referring to how some of
the latest government steps such as indexation of MNEREGA wages to CPI-AL, ballooning
subsidy bill etc. are complicating demand management. Rather critical of the government
finances, RBI notes that inflation management would be difficult in the face of the
government faltering in its fiscal consolidation plans.
Even as challenges remain on containment of inflation from other arenas, RBI hopes that the
current tightening phase of monetary policy would serve the purpose of preventing the
persistent food and energy inflation from spilling over into more generalized inflation. It
would also want to rein in inflationary pressures, which remain at elevated levels owing to
the persistent price pressures on the food side. With continued pricing power from
corporate houses and indications of wage adjustments, both in the urban and rural sectors,
RBI would hope that its policy stance helps to address demand-related price pressures and
avoid a wage-price spiral.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Economy
Monetary Policy
3QFY11 Credit Policy review: Desperate on inflation, calibrated in action. RBI
remained hawkish in its stance on inflation and hiked repo and reverse repo rates by 25
bps each. There was no change in CRR. The monetary policy stance continues to be
squarely focused on inflation management as RBI increased its end-FY2011E estimate to
7% from 5.5%. RBI remains confident of domestic growth but does sound worried that
the growth might not be broad-based. Rightly, fiscal issues come to the fore in this
document and are thought to be preventing the efficiency of monetary policy actions.
No surprises in terms of policy action; repo and reverse repo rates hiked by 25 bps each
Inflation being the dominant theme of the policy, RBI hiked the repo and reverse repo rates by 25
bps each keeping the CRR and the SLR unchanged. Liquidity support to SCBs under LAF to the
extent of 1% of NDTL was extended to April 8, 2011 from the erstwhile expiry on January 28,
2011. The second LAF will continue to be conducted on a daily basis till April 8. Though consensus
was for a 25 bps hike, the markets had started anticipating a 50 bps hike on the back of a sudden
sharp rise in the Headline WPI number for December. But the RBI chose to tread a calibrated path
and assess the implications of the previous hikes on the growth dynamics. This is important in light
of the slackness shown by the industrial production and expectations that the IIP yoy growth for
December could dip into the negative zone.
Growth not a concern; inflation estimate for end-FY2011E upped to 7%
RBI retained its GDP target for FY2011E at 8.5% with some bias to the upside. In the
Macroeconomic and Monetary Development report (released yesterday), RBI appeared concerned
that manufacturing sector growth is still not broad-based and nearly 73% of the overall growth
comes from the top-5 manufacturing industries. In FY2012E RBI expects growth to come down
slightly on the back of agricultural sector trending lower. On inflation, RBI expects the current
spike in food inflation to be transitory but structural demand-supply mismatches will keep food
inflation high. It notes that non-food manufacturing inflation remains above the medium-term
trend of 4%. RBI expects inflation in 2011 to be a global concern driven by supply constraints and
rising demand as the developed countries start to recover. RBI consequently has revised up the
end-FY2011E estimates by 150 bps to 7%.
CAD and fiscal situation also seen as risks to economic stability
Apart from rising inflationary expectations, CAD and fiscal situation are highlighted as contributing
to the “increased uncertainty about economic stability that consumers and investors will have to
deal with”. RBI estimates CAD/GDP at 3.5% which is not sustainable and RBI expects policy efforts
to diversify exports and bring down CAD. However, even as slower growth can correct CAD, it
also has implications in terms of lowering capital flows and asset prices, thereby probably
aggravating some of the economic risks. This is probably another reason why RBI could be
desisting from aggressively raising policy interest rates. RBI also raises concerns on budgetary
provisions of subsidies which in a rising oil price scenario threaten to derail fiscal consolidation if
the higher prices are not passed through.
We reiterate our call for added 75-100 bps hike in repo and reverse repo rates through FY2012E
We expect RBI to move repo rate to 7.25-7.5% and reverse repo rate to 6.25-6.5% by end-
FY2012E but in calibrated steps of 25 bps each and at the quarterly meetings. Under current
circumstances, we do not envisage the use of CRR as tight liquidity is likely to stay to enable
monetary policy transmission.
RBI raises a pertinent issue: Its battle against inflation will continue to stay futile
without fiscal consolidation
Inflation has undoubtedly emerged as a “dominant concern” for policymakers with risks to
inflation clearly on the upside. We have for long been highlighting the likelihood of Headline
WPI ending closer to 7.0-7.5% by March 2011-end (see our note released on January 14,
2011 ‘December WPI: Inflation combating on in full swing’). RBI has also moved closer to
our estimate as it raised its end-FY2011 Headline WPI projection to 7.0% from earlier
estimate of 5.5%.
The onus of bringing inflation under control to a large extent has fallen on RBI. However,
the central bank alone is unlikely to win the battle against inflation as monetary policy is
rendered ineffective in addressing supply-side price shocks, which have been at the root of
the current bout of domestic inflation. As highlighted by us in our previous reports, the
uptrend in domestic inflation is largely a result of structural imbalances in several food items
such as milk, eggs, meat etc. Moreover, transitory supply shocks as seen in the case of
vegetables such as onions and tomatoes as also fuel price increases have further added to
the inflationary pressures. Additionally, the surging global food and commodity prices have
further exacerbated the domestic inflation outlook.
RBI has clearly recognized its limitation in addressing the price pressures emanating from the
above factors. In fact, in the policy document RBI indicates the “need for rapid action to
increase the output of a number of products, the demand for which is being driven by
changing consumption patters reflecting increasing incomes.” Unless the supply-side factors
are addressed, food inflation could become entrenched, thereby threatening growth
sustainability.
Additionally, RBI stresses that “monetary policy works most efficiently while dealing with an
inflationary situation when the fiscal situation is under control”, referring to how some of
the latest government steps such as indexation of MNEREGA wages to CPI-AL, ballooning
subsidy bill etc. are complicating demand management. Rather critical of the government
finances, RBI notes that inflation management would be difficult in the face of the
government faltering in its fiscal consolidation plans.
Even as challenges remain on containment of inflation from other arenas, RBI hopes that the
current tightening phase of monetary policy would serve the purpose of preventing the
persistent food and energy inflation from spilling over into more generalized inflation. It
would also want to rein in inflationary pressures, which remain at elevated levels owing to
the persistent price pressures on the food side. With continued pricing power from
corporate houses and indications of wage adjustments, both in the urban and rural sectors,
RBI would hope that its policy stance helps to address demand-related price pressures and
avoid a wage-price spiral.
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