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India: RBI Monetary Policy Review (May 2011)
Key Facts
‰ The RBI hiked the repo and reverse rates by
50bp at its May annual policy review.
‰ Inflation control is adopted as the sole
short-term objective of monetary policy.
‰ March 2012 WPI forecast of 6% with upside
risk shows clear bias to hike again.
‰ Upside risks to the RBI’s growth and inflation
forecasts argue for an 8% end-2011 repo rate.
The RBI jettisons its so-far ‘calibrated’ approach to rate
hikes and delivers a 50bp rate hike. Inflation control,
even at the cost of demand destruction in the short
term, is now the primary goal of monetary policy. The
RBI’s revised forecasts anticipate slower growth but
sticky inflation in the short term means the RBI retains
a clear bias to hike further. Our analysis suggests that
the risks to both the RBI’s growth and inflation
forecasts are skewed to the upside, suggesting
considerable work is yet to be done by the central
bank. We now target an 8% year-end repo rate.
In a welcome move, the RBI picked up the pace of policy
tightening in its annual policy review today, lifting both the repo
rate and the reverse repo rate by 50bp to 7.25% and 6.25%
respectively. As had been foreshadowed in its recent Working
Group Review, the RBI adopted a new operating practice for
monetary policy. The repo rate is now formally the key policy
signalling rate while the LAF corridor now has a fixed ceiling of
the Marginal Standing Facility (MSF) rate – effectively the
discount rate – of 100bp above the repo rate. The floor will be
the reverse repo rate fixed at 100bp below the repo rate. The
overnight call money rate is the operating target for the repo
rate with the RBI stabilising this rate around the repo rate.
Today’s 50bp rate hike brings the RBI’s tightening up to 425bp.
The policy statement that accompanied the decision was
palpably hawkish. In stark language, central bank governor
Subbarao acknowledged that inflation control, even at the cost
of slower growth in the short term, is now the dominant driver of
monetary policy. Clearly concerned at evidence that inflation
expectations are becoming unglued, the governor
acknowledged that failure to control inflation will harm growth
more over the longer term. The RBI’s new growth and inflation
forecasts are crucial in determining both how the central bank
currently views the policy outlook and where the balance of
risks lies. On growth, the RBI was relatively downbeat,
choosing to emphasise the slowdown in the highly volatile and
unreliable official industrial production data as evidence that
earlier policy tightening has already gaining traction. Its new
FY2012 GDP forecast was pegged at 8% with the other two key
forecast assumptions of a ‘good’ monsoon and an average
$110 per barrel oil assumption this year. Fiscal slippage is seen
as key upside risk to growth. On inflation, the RBI sees clear
upside risks from further gains in commodity prices and it
assumes that administered fuel prices will be lifted in the next
few months. WPI inflation is forecast to be sticky around current
levels i.e. c.9% for the next 6 months or so before declining to
around 6% by March 2012 albeit with an ‘upward bias.’ And the
policy statement was at pains to note that even this outcome is
dependent upon ‘appropriate policy actions over the year’.
The RBI clearly retains a bias to hike further and expects to
deliver further rate hikes. The question how much and how
quickly? Our judgement is that the risks to both the RBI’s
growth and inflation forecasts are skewed to the upside,
implying the central bank may have more work to do than it
expects. On growth, the slowdown in the official IP data that the
RBI emphasised has been driven by the volatile capital goods
output which has proved highly unreliable in the past. Key
surveys such as the PMI manufacturing survey remain robust
and likely provide a better guide than the IP data whose validity
the RBI has itself questioned in the past. A range of demand
side indicators such as cement production, railway traffic and
bank credit – all show little, if any, signs of moderation. Given
the Budget’s roseate assumptions about commodity prices this
year, our sense is that fiscal slippage is a virtual given. On
balance, growth is likely to overshoot the RBI’s expectations at
least in the short term. Risks to inflation remain heavily skewed
to the upside as well, not least given the serial tendency for
initial estimates of WPI inflation to be revised higher (see Key
Chart). We are likely to discover that March WPI inflation was
closer to 10% than 9%. Both the monsoon and global
commodity prices are upside risks as the RBI acknowledges.
Accordingly we now target a three more rate hikes this year,
taking the repo rate to 8% by end-2011 (previously 7.50%) and
a further 50bp of hike in 2012H1. Forward rates spiked on the
RBI’s announcement and the swaps curve bear flattened (see
Key Chart). And with policy headwinds still blowing hard,
equities will remain under pressure.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India: RBI Monetary Policy Review (May 2011)
Key Facts
‰ The RBI hiked the repo and reverse rates by
50bp at its May annual policy review.
‰ Inflation control is adopted as the sole
short-term objective of monetary policy.
‰ March 2012 WPI forecast of 6% with upside
risk shows clear bias to hike again.
‰ Upside risks to the RBI’s growth and inflation
forecasts argue for an 8% end-2011 repo rate.
The RBI jettisons its so-far ‘calibrated’ approach to rate
hikes and delivers a 50bp rate hike. Inflation control,
even at the cost of demand destruction in the short
term, is now the primary goal of monetary policy. The
RBI’s revised forecasts anticipate slower growth but
sticky inflation in the short term means the RBI retains
a clear bias to hike further. Our analysis suggests that
the risks to both the RBI’s growth and inflation
forecasts are skewed to the upside, suggesting
considerable work is yet to be done by the central
bank. We now target an 8% year-end repo rate.
In a welcome move, the RBI picked up the pace of policy
tightening in its annual policy review today, lifting both the repo
rate and the reverse repo rate by 50bp to 7.25% and 6.25%
respectively. As had been foreshadowed in its recent Working
Group Review, the RBI adopted a new operating practice for
monetary policy. The repo rate is now formally the key policy
signalling rate while the LAF corridor now has a fixed ceiling of
the Marginal Standing Facility (MSF) rate – effectively the
discount rate – of 100bp above the repo rate. The floor will be
the reverse repo rate fixed at 100bp below the repo rate. The
overnight call money rate is the operating target for the repo
rate with the RBI stabilising this rate around the repo rate.
Today’s 50bp rate hike brings the RBI’s tightening up to 425bp.
The policy statement that accompanied the decision was
palpably hawkish. In stark language, central bank governor
Subbarao acknowledged that inflation control, even at the cost
of slower growth in the short term, is now the dominant driver of
monetary policy. Clearly concerned at evidence that inflation
expectations are becoming unglued, the governor
acknowledged that failure to control inflation will harm growth
more over the longer term. The RBI’s new growth and inflation
forecasts are crucial in determining both how the central bank
currently views the policy outlook and where the balance of
risks lies. On growth, the RBI was relatively downbeat,
choosing to emphasise the slowdown in the highly volatile and
unreliable official industrial production data as evidence that
earlier policy tightening has already gaining traction. Its new
FY2012 GDP forecast was pegged at 8% with the other two key
forecast assumptions of a ‘good’ monsoon and an average
$110 per barrel oil assumption this year. Fiscal slippage is seen
as key upside risk to growth. On inflation, the RBI sees clear
upside risks from further gains in commodity prices and it
assumes that administered fuel prices will be lifted in the next
few months. WPI inflation is forecast to be sticky around current
levels i.e. c.9% for the next 6 months or so before declining to
around 6% by March 2012 albeit with an ‘upward bias.’ And the
policy statement was at pains to note that even this outcome is
dependent upon ‘appropriate policy actions over the year’.
The RBI clearly retains a bias to hike further and expects to
deliver further rate hikes. The question how much and how
quickly? Our judgement is that the risks to both the RBI’s
growth and inflation forecasts are skewed to the upside,
implying the central bank may have more work to do than it
expects. On growth, the slowdown in the official IP data that the
RBI emphasised has been driven by the volatile capital goods
output which has proved highly unreliable in the past. Key
surveys such as the PMI manufacturing survey remain robust
and likely provide a better guide than the IP data whose validity
the RBI has itself questioned in the past. A range of demand
side indicators such as cement production, railway traffic and
bank credit – all show little, if any, signs of moderation. Given
the Budget’s roseate assumptions about commodity prices this
year, our sense is that fiscal slippage is a virtual given. On
balance, growth is likely to overshoot the RBI’s expectations at
least in the short term. Risks to inflation remain heavily skewed
to the upside as well, not least given the serial tendency for
initial estimates of WPI inflation to be revised higher (see Key
Chart). We are likely to discover that March WPI inflation was
closer to 10% than 9%. Both the monsoon and global
commodity prices are upside risks as the RBI acknowledges.
Accordingly we now target a three more rate hikes this year,
taking the repo rate to 8% by end-2011 (previously 7.50%) and
a further 50bp of hike in 2012H1. Forward rates spiked on the
RBI’s announcement and the swaps curve bear flattened (see
Key Chart). And with policy headwinds still blowing hard,
equities will remain under pressure.
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