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● The Reserve Bank of India’s 25 bp rate hike was the tenth
increase in the current tightening cycle and takes the cumulative
increase in the repo rate to 275 bp. A further hike was pretty much
guaranteed following the poor wholesale price inflation numbers
for May released earlier in the week.
● The economy and markets currently face a triple whammy of high
and sticky inflation, high and rising inflation and slowing economic
growth. In our view, this unpleasant combination is going to
remain in place for a few months yet.
● Inflation is unlikely to take a decisive turn for the better until the
October-December quarter this year, while we expect at least
another 50 bp of rate hikes as well as further downside growth
surprises. Our GDP growth forecast remains at a bottom-of-therange
7.5% for both 2011/12 and 2012/13.
● A period of sub-trend is, however, exactly what India needs to
break the wage-price spiral and free up some spare capacity.
Only then can we be confident of a strong, sustained recovery in
economic activity.
The Reserve Bank of India met consensus market expectations
this time (having surprised with its 50 bp hike in early May) by
raising 25 bp. This takes the repo rate up to 7.5% and means the
cumulative increase in the current cycle now amounts to 275 bp.
When one also takes account of the domestic liquidity squeeze, which
has pushed up market interest rates by roughly 450 bp, then it is clear
that India has experienced a sizeable monetary tightening by any
standards. Yes, the real policy rate is still negative but not many can
borrow at that rate! The commercial bank’s real lending rate is more
like +3%.
The RBI’s accompanying statement points to further hikes ahead.
While the central bank recognised that the “global environment has
changed for the worse” most of the comments remained hawkish. In
particular, it commented that “the challenge to maintain inflation still
persists” and that it would “continue with its anti-inflationary policy”.
We expect another 50 bp of hikes in two further 25 bp steps but the
risks to this, if anything, are on the upside.
The economy will probably feel the effect of the monetary
tightening more than generally anticipated. Our statistical analysis
(see India: Livin’ on a prayer, 19 November 2010) suggests that
interest rates have a powerful impact on Indian economic growth, with
the full effects typically taking a lengthy 12-18 months to come
through. It is worth noting, that the amount of leverage in the economy
– as proxied by the outstanding stock of bank lending as a percentage
of GDP – has roughly doubled over the last decade much to the
surprise of many we have relayed this information too. Overall, we
expect many in the market to be surprised both by the extent to which
economic growth reacts to the tightening in monetary conditions as
well as the persistence of the impact.
Further weakness ahead. Putting the interest rate impact together
with the negative effects from the oil price rise, stronger real exchange
rate and a soft-patch in overseas demand then it seems to us that
India has the recipe for a meaningful and prolonged period of subtrend
growth. Our 7.5% fiscal year average growth numbers for both
2011/12 and 2012/13 compare with consensus growth forecasts (as
per the May edition of Consensus Forecasts – the latest available at
the time of writing) of 8.0% and 8.5% respectively, although the risks
to our numbers are probably on the dowside.
A necessary evil. The good news is that, in the absence of a longawaited
positive supply shock, an economic downturn is exactly what
India requires to temper its underlying inflation problems. The obvious
danger involved with a sizeable interest rate tightening is that it will
discourage the investment spending necessary to help ease the
country’s capacity constraints. But at this stage the RBI’s number one
priority must be to break the wage-price spiral, which itself is
extremely harmful to the country’s investment propsects.
What happens next? For any central bank, determining when it has
done enough to achieve its policy goals is extremely difficult, but for
the RBI this is further complicated by the absence of a decent
measure of underlying inflation. It looks to us that Governor Subbarao
is paying closer attention to wholesale price inflation than some of his
predecessors, despite the fact that series is largely determined by
international commodity price developments. In our view, base effects
mean WPI inflation will start falling in a meaningful fashion in the
October-December quarter, dropping to about 6% by the end of the
fiscal year in March 2012. As such, we are looking for the last rate
hike to come at the mid-September meeting (by which time only the
August WPI will be known), with the repo rate peaking at 8%.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
● The Reserve Bank of India’s 25 bp rate hike was the tenth
increase in the current tightening cycle and takes the cumulative
increase in the repo rate to 275 bp. A further hike was pretty much
guaranteed following the poor wholesale price inflation numbers
for May released earlier in the week.
● The economy and markets currently face a triple whammy of high
and sticky inflation, high and rising inflation and slowing economic
growth. In our view, this unpleasant combination is going to
remain in place for a few months yet.
● Inflation is unlikely to take a decisive turn for the better until the
October-December quarter this year, while we expect at least
another 50 bp of rate hikes as well as further downside growth
surprises. Our GDP growth forecast remains at a bottom-of-therange
7.5% for both 2011/12 and 2012/13.
● A period of sub-trend is, however, exactly what India needs to
break the wage-price spiral and free up some spare capacity.
Only then can we be confident of a strong, sustained recovery in
economic activity.
The Reserve Bank of India met consensus market expectations
this time (having surprised with its 50 bp hike in early May) by
raising 25 bp. This takes the repo rate up to 7.5% and means the
cumulative increase in the current cycle now amounts to 275 bp.
When one also takes account of the domestic liquidity squeeze, which
has pushed up market interest rates by roughly 450 bp, then it is clear
that India has experienced a sizeable monetary tightening by any
standards. Yes, the real policy rate is still negative but not many can
borrow at that rate! The commercial bank’s real lending rate is more
like +3%.
The RBI’s accompanying statement points to further hikes ahead.
While the central bank recognised that the “global environment has
changed for the worse” most of the comments remained hawkish. In
particular, it commented that “the challenge to maintain inflation still
persists” and that it would “continue with its anti-inflationary policy”.
We expect another 50 bp of hikes in two further 25 bp steps but the
risks to this, if anything, are on the upside.
The economy will probably feel the effect of the monetary
tightening more than generally anticipated. Our statistical analysis
(see India: Livin’ on a prayer, 19 November 2010) suggests that
interest rates have a powerful impact on Indian economic growth, with
the full effects typically taking a lengthy 12-18 months to come
through. It is worth noting, that the amount of leverage in the economy
– as proxied by the outstanding stock of bank lending as a percentage
of GDP – has roughly doubled over the last decade much to the
surprise of many we have relayed this information too. Overall, we
expect many in the market to be surprised both by the extent to which
economic growth reacts to the tightening in monetary conditions as
well as the persistence of the impact.
Further weakness ahead. Putting the interest rate impact together
with the negative effects from the oil price rise, stronger real exchange
rate and a soft-patch in overseas demand then it seems to us that
India has the recipe for a meaningful and prolonged period of subtrend
growth. Our 7.5% fiscal year average growth numbers for both
2011/12 and 2012/13 compare with consensus growth forecasts (as
per the May edition of Consensus Forecasts – the latest available at
the time of writing) of 8.0% and 8.5% respectively, although the risks
to our numbers are probably on the dowside.
A necessary evil. The good news is that, in the absence of a longawaited
positive supply shock, an economic downturn is exactly what
India requires to temper its underlying inflation problems. The obvious
danger involved with a sizeable interest rate tightening is that it will
discourage the investment spending necessary to help ease the
country’s capacity constraints. But at this stage the RBI’s number one
priority must be to break the wage-price spiral, which itself is
extremely harmful to the country’s investment propsects.
What happens next? For any central bank, determining when it has
done enough to achieve its policy goals is extremely difficult, but for
the RBI this is further complicated by the absence of a decent
measure of underlying inflation. It looks to us that Governor Subbarao
is paying closer attention to wholesale price inflation than some of his
predecessors, despite the fact that series is largely determined by
international commodity price developments. In our view, base effects
mean WPI inflation will start falling in a meaningful fashion in the
October-December quarter, dropping to about 6% by the end of the
fiscal year in March 2012. As such, we are looking for the last rate
hike to come at the mid-September meeting (by which time only the
August WPI will be known), with the repo rate peaking at 8%.
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