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RBI's macroeconomic review released ahead of the monetary policy statement tomorrow
suggests continuation of its anti-inflationary monetary stance. This implies additional policy
rate hike(s) post tomorrow's expected 25 bp policy rate hike.
Anti-inflationary stance maintained despite growth slowdown
Though the RBI recognized the increased downside risks to growth, with the broad based
slowdown in industrial production growth in April and May, it has chosen to continue with
its anti-inflationary stance. The RBI expects GDP growth to stay around trend growth of
around 8%.
Expect additional rate hike(s) post the 25 bp rate hike tomorrow
We had expected RBI to pause its monetary tightening cycle with a policy rate hike of 25
bp tomorrow. However, the anti-inflationary stance in the macroeconomic review
suggests that we may see additional rate hike(s) post tomorrow's 25 bp rate hike.
That said, consensus expectations were for another 25-50 bp of additional rate hikes
post tomorrow's 25 bp policy rate hike. As such, consensus expectations for policy rate
hikes may not move much further. However, the overnight interest rate swap (OIS)
market had been pricing in only tomorrow's rate hike, and may need to adjust its
expectations.
Why the divergence versus our thesis?
We had expected the RBI to end its monetary tightening cycle tomorrow as a) we believe
seasonally adjusted core manufacturing inflation peaked in February/March (which is
also supported by the RBI's data), b) b) the 425 bp of effective policy rate hikes by the
RBI since March 2010 had tempered domestic demand, as reflected by the slowdown in
industrial production and credit sensitive sectors (e.g., auto sales). Separately, the
expected (and ongoing) decline in corporate margins in the June quarter suggested that
corporate pricing power was waning.
The RBI has recognized the growth slowdown and the reduction in corporate pricing power in
its macroeconomic review, but continues to be concerned by persistently high inflation and its
expected slow decline. The Reserve Bank wants to break the inertial dynamics of wage and
food price rise, and also further temper credit growth. Yoy credit growth of 19.9% in early July
was slightly above RBI's indicated target of 19.0% for FY12; importantly, non-food credit
growth has remained high in the financial year so far, in contrast to the seasonal slack
generally seen during this period.
Core manufacturing inflation continues to be a focus
The macroeconomic review states that "near term trends on non food mfg inflation critical in
shaping future macro-economic dynamics".
Key quotes regarding the monetary policy stance are as follows (they have a hawkish tone):
Current conditions require "continued anti-inflationary bias with a close watch and nimblefooted calibration to new information".
Monetary policy will have to preserve the broad thrust on tight monetary stance till there is
credible evidence of inflation trending close to a level within the Reserve Bank's comfort zone.
The challenge at this juncture is to contain inflationary pressures, while factoring in the lags in
transmission of the monetary policy action. The task of monetary policy is made complex as
these lags are often long and variable in length.
Other key takeaways from the macroeconomic review
The RBI expects GDP growth for FY12 to "stay around 8% because of still strong
consumption growth as monsoon may be close to normal and service sector momentum has
been maintained".
Oil subsidy related fiscal deficit slippage to be about 1% of GDP, with 0.5% overshoot from
actual level of petroleum subsidy versus budgeted level, and revenue losses of 0.3% linked to
elimination/reduction of customs/ excise duty on petroleum products.
Upside risks to inflation risks are linked to the following: a) food inflation could stay high
despite a normal monsoon due to higher MSPs (minimum support prices), b) incomplete pass
through of international crude oil prices to retail fuel prices, and c) electricity price inflation
given the increases in input costs of coal and mineral oils.
The three important factors that could significantly alter the baseline path of growth and
inflation are: (1) significant departure of monsoon from 'normal', (2) a collapse or rebuild of
global commodity price bubble, and (3) Euro zone debt crisis assuming a full-blown
proportion.
Real rates are positive on an ex-ante basis even for policy rates given a policy repo rate of
7.5% and projected inflation of 6%, and are positive even on an ex-post basis for real lending
rates.
The RBI thinks that execution is more important for investment pick up than a reduction in
interest rates. Quoting from the macroeconomic review: "The slowdown in consumption has
been restricted so far to interest rate sensitive sectors like car sales getting impacted. Some
re-balancing of demand towards investment would be helpful, and industrial policy action and
execution could go a long way to help bring about this rebalancing."
Staying bullish markets though rate peak catalyst seems pushed out
The RBI's macroeconomic review does suggest that we may have been a bit optimistic in
expecting an end to policy rate hikes post tomorrow's expected policy rate hike. That said,
though policy rates may go up an additional 25-50 bp, we think that effective lending and
deposit rates may have already peaked in many instances; e.g., the current three month
certificate of deposit rate of 8.75% are significantly below their peak of 10.1% in late March.
We continue to be buyers of Indian equities as valuations have moderated and we believe
interest rates are close to peaking out (though the policy rate peak has been pushed out a bit
versus our earlier expectation).
Our model portfolio is overweight interest rate sensitive stocks (wholesale funded banks and
financial institutions and autos)
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
RBI's macroeconomic review released ahead of the monetary policy statement tomorrow
suggests continuation of its anti-inflationary monetary stance. This implies additional policy
rate hike(s) post tomorrow's expected 25 bp policy rate hike.
Anti-inflationary stance maintained despite growth slowdown
Though the RBI recognized the increased downside risks to growth, with the broad based
slowdown in industrial production growth in April and May, it has chosen to continue with
its anti-inflationary stance. The RBI expects GDP growth to stay around trend growth of
around 8%.
Expect additional rate hike(s) post the 25 bp rate hike tomorrow
We had expected RBI to pause its monetary tightening cycle with a policy rate hike of 25
bp tomorrow. However, the anti-inflationary stance in the macroeconomic review
suggests that we may see additional rate hike(s) post tomorrow's 25 bp rate hike.
That said, consensus expectations were for another 25-50 bp of additional rate hikes
post tomorrow's 25 bp policy rate hike. As such, consensus expectations for policy rate
hikes may not move much further. However, the overnight interest rate swap (OIS)
market had been pricing in only tomorrow's rate hike, and may need to adjust its
expectations.
Why the divergence versus our thesis?
We had expected the RBI to end its monetary tightening cycle tomorrow as a) we believe
seasonally adjusted core manufacturing inflation peaked in February/March (which is
also supported by the RBI's data), b) b) the 425 bp of effective policy rate hikes by the
RBI since March 2010 had tempered domestic demand, as reflected by the slowdown in
industrial production and credit sensitive sectors (e.g., auto sales). Separately, the
expected (and ongoing) decline in corporate margins in the June quarter suggested that
corporate pricing power was waning.
The RBI has recognized the growth slowdown and the reduction in corporate pricing power in
its macroeconomic review, but continues to be concerned by persistently high inflation and its
expected slow decline. The Reserve Bank wants to break the inertial dynamics of wage and
food price rise, and also further temper credit growth. Yoy credit growth of 19.9% in early July
was slightly above RBI's indicated target of 19.0% for FY12; importantly, non-food credit
growth has remained high in the financial year so far, in contrast to the seasonal slack
generally seen during this period.
Core manufacturing inflation continues to be a focus
The macroeconomic review states that "near term trends on non food mfg inflation critical in
shaping future macro-economic dynamics".
Key quotes regarding the monetary policy stance are as follows (they have a hawkish tone):
Current conditions require "continued anti-inflationary bias with a close watch and nimblefooted calibration to new information".
Monetary policy will have to preserve the broad thrust on tight monetary stance till there is
credible evidence of inflation trending close to a level within the Reserve Bank's comfort zone.
The challenge at this juncture is to contain inflationary pressures, while factoring in the lags in
transmission of the monetary policy action. The task of monetary policy is made complex as
these lags are often long and variable in length.
Other key takeaways from the macroeconomic review
The RBI expects GDP growth for FY12 to "stay around 8% because of still strong
consumption growth as monsoon may be close to normal and service sector momentum has
been maintained".
Oil subsidy related fiscal deficit slippage to be about 1% of GDP, with 0.5% overshoot from
actual level of petroleum subsidy versus budgeted level, and revenue losses of 0.3% linked to
elimination/reduction of customs/ excise duty on petroleum products.
Upside risks to inflation risks are linked to the following: a) food inflation could stay high
despite a normal monsoon due to higher MSPs (minimum support prices), b) incomplete pass
through of international crude oil prices to retail fuel prices, and c) electricity price inflation
given the increases in input costs of coal and mineral oils.
The three important factors that could significantly alter the baseline path of growth and
inflation are: (1) significant departure of monsoon from 'normal', (2) a collapse or rebuild of
global commodity price bubble, and (3) Euro zone debt crisis assuming a full-blown
proportion.
Real rates are positive on an ex-ante basis even for policy rates given a policy repo rate of
7.5% and projected inflation of 6%, and are positive even on an ex-post basis for real lending
rates.
The RBI thinks that execution is more important for investment pick up than a reduction in
interest rates. Quoting from the macroeconomic review: "The slowdown in consumption has
been restricted so far to interest rate sensitive sectors like car sales getting impacted. Some
re-balancing of demand towards investment would be helpful, and industrial policy action and
execution could go a long way to help bring about this rebalancing."
Staying bullish markets though rate peak catalyst seems pushed out
The RBI's macroeconomic review does suggest that we may have been a bit optimistic in
expecting an end to policy rate hikes post tomorrow's expected policy rate hike. That said,
though policy rates may go up an additional 25-50 bp, we think that effective lending and
deposit rates may have already peaked in many instances; e.g., the current three month
certificate of deposit rate of 8.75% are significantly below their peak of 10.1% in late March.
We continue to be buyers of Indian equities as valuations have moderated and we believe
interest rates are close to peaking out (though the policy rate peak has been pushed out a bit
versus our earlier expectation).
Our model portfolio is overweight interest rate sensitive stocks (wholesale funded banks and
financial institutions and autos)
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