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After thirteen interest rate rises, which have seen the Reserve
Bank lift the repo rate from 4.75% to 8.5%, today’s 25 bp hike is
likely to be the last in the tightening cycle.
● For the first time in a long time, the RBI suggested the downside
risks to economic growth were sufficiently large to be taken more
explicit account of. This is despite the fact that inflation remains way
above its comfort zone and price expectations are dangerously
elevated. Clearly, the RBI is banking on the prospect of weaker
growth eventually bringing down underlying inflationary pressures.
● We agree with the central bank that inflation will start to fall in a
meaningful fashion with the release of the December WPI
numbers and expect the combination of declining inflation and
further downside growth surprises to lead the RBI to start cutting
rates from the April-June quarter of next year.
● In our view, the central bank has done enough to engineer a
protracted period of sub-trend growth, essential to ease some of
the bottlenecks present in the economy over recent years.
The RBI met the expectations of most, including ourselves, by
raising the repo and reverse repo rate by 25 bp. The real
excitement, however, was provided by the statement where the
central bank suggested that “the likelihood of a rate action in the
December mid-quarter review is relatively low”. Adding that “if the
inflation trajectory conforms to projections, further rate hikes may not
be warranted”. Admittedly, a similar sort of statement was made in
August/September last year, which ultimately proved misleading. But
we believe this has far more credibility.
Although a long time in coming, the RBI indicated that downside
growth risks are sufficiently large to be taken more account of.
The key statement here was as follows: “Changing the policy stance
when inflation is still far above the tolerance level entails risks to the
credibility of the Reserve Bank’s commitment to low and stable
inflation. However, growth risks are undoubtedly significant in the
current scenario, and these need to be given due consideration.” In
order to reflect this, the RBI cut its own 2011/12 average GDP growth
projection to 7.6% from 8.0%. This compares with a consensus
forecast of 7.5% and our own forecast of 7.2%.
We are confident that today’s move will indeed be the last in the
current cycle. We are also sticking with the view that rate cuts will
begin in fiscal 1Q next year (most likely in April or May).
In our view, the RBI is right in expecting inflation to drop from
December this year. In fact, we believe the risks to its 7% end-
March WPI inflation forecast are slightly on the downside. The
key reasons behind this view are set out in Devika Mehndiratta’s
recent report “India’s sticky-high inflation” (4 October). In it she argues
that the drop in international commodity price inflation which has
already taken place and which is likely to continue, notwithstanding
the weakness of the rupee, should knock around 3 percentage points
off the headline rate by March. Weaker domestic growth will also have
a small additional impact on our own measure of core WPI inflation
which strips out food and other products related to the global
commodity cycle from the manufacturing component.
By April/May next year we are also likely to have seen at least
one quarter of sub-7% year-on-year GDP growth. This could
happen as soon as the July-September GDP print which is due to be
released on 30 November. In our view, it is the likely combination of
headline WPI inflation and GDP growth both starting with a six which
will push the RBI into reversing its monetary course.
Has the RBI tightened too much? This is a very difficult question
and one which can perhaps only be definitively answered in a year or
two. For what it’s worth, however, we believe the bank’s tough action,
which has seen the repo rate rise 375 bp since March 2010, was
warranted. While rates were cut too much during the Global Financial
Crisis (easy to say in hindsight) and hiked too slowly during the initial
stages of the tightening process, for a long time now our view has
been that an extended period of sub-trend growth is exactly what the
country requires to bring down inflation expectations. Although the
monetary tightening will obviously do little to boost investment and the
supply side of the economy, nor would a wage-price spiral that risks
getting out of control. Quite rightly, the central bank’s priority has been
to try and break the inflationary spiral and, in our view, the lagged
impact of the all rate rises has a good chance of doing that. The RBI is
also correct to imply that the government hasn’t exactly pulled its
weight in helping control underlying inflationary pressures in recent
times.
By way of a footnote, the RBI also announced a deregulation of
the savings deposit interest rate. This follows on from the release of
a discussion paper on the subject that was published in April this year
and means that, with immediate effect, banks are free to determine
their own savings bank deposit rate with a couple of reasonably minor
conditions.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
After thirteen interest rate rises, which have seen the Reserve
Bank lift the repo rate from 4.75% to 8.5%, today’s 25 bp hike is
likely to be the last in the tightening cycle.
● For the first time in a long time, the RBI suggested the downside
risks to economic growth were sufficiently large to be taken more
explicit account of. This is despite the fact that inflation remains way
above its comfort zone and price expectations are dangerously
elevated. Clearly, the RBI is banking on the prospect of weaker
growth eventually bringing down underlying inflationary pressures.
● We agree with the central bank that inflation will start to fall in a
meaningful fashion with the release of the December WPI
numbers and expect the combination of declining inflation and
further downside growth surprises to lead the RBI to start cutting
rates from the April-June quarter of next year.
● In our view, the central bank has done enough to engineer a
protracted period of sub-trend growth, essential to ease some of
the bottlenecks present in the economy over recent years.
The RBI met the expectations of most, including ourselves, by
raising the repo and reverse repo rate by 25 bp. The real
excitement, however, was provided by the statement where the
central bank suggested that “the likelihood of a rate action in the
December mid-quarter review is relatively low”. Adding that “if the
inflation trajectory conforms to projections, further rate hikes may not
be warranted”. Admittedly, a similar sort of statement was made in
August/September last year, which ultimately proved misleading. But
we believe this has far more credibility.
Although a long time in coming, the RBI indicated that downside
growth risks are sufficiently large to be taken more account of.
The key statement here was as follows: “Changing the policy stance
when inflation is still far above the tolerance level entails risks to the
credibility of the Reserve Bank’s commitment to low and stable
inflation. However, growth risks are undoubtedly significant in the
current scenario, and these need to be given due consideration.” In
order to reflect this, the RBI cut its own 2011/12 average GDP growth
projection to 7.6% from 8.0%. This compares with a consensus
forecast of 7.5% and our own forecast of 7.2%.
We are confident that today’s move will indeed be the last in the
current cycle. We are also sticking with the view that rate cuts will
begin in fiscal 1Q next year (most likely in April or May).
In our view, the RBI is right in expecting inflation to drop from
December this year. In fact, we believe the risks to its 7% end-
March WPI inflation forecast are slightly on the downside. The
key reasons behind this view are set out in Devika Mehndiratta’s
recent report “India’s sticky-high inflation” (4 October). In it she argues
that the drop in international commodity price inflation which has
already taken place and which is likely to continue, notwithstanding
the weakness of the rupee, should knock around 3 percentage points
off the headline rate by March. Weaker domestic growth will also have
a small additional impact on our own measure of core WPI inflation
which strips out food and other products related to the global
commodity cycle from the manufacturing component.
By April/May next year we are also likely to have seen at least
one quarter of sub-7% year-on-year GDP growth. This could
happen as soon as the July-September GDP print which is due to be
released on 30 November. In our view, it is the likely combination of
headline WPI inflation and GDP growth both starting with a six which
will push the RBI into reversing its monetary course.
Has the RBI tightened too much? This is a very difficult question
and one which can perhaps only be definitively answered in a year or
two. For what it’s worth, however, we believe the bank’s tough action,
which has seen the repo rate rise 375 bp since March 2010, was
warranted. While rates were cut too much during the Global Financial
Crisis (easy to say in hindsight) and hiked too slowly during the initial
stages of the tightening process, for a long time now our view has
been that an extended period of sub-trend growth is exactly what the
country requires to bring down inflation expectations. Although the
monetary tightening will obviously do little to boost investment and the
supply side of the economy, nor would a wage-price spiral that risks
getting out of control. Quite rightly, the central bank’s priority has been
to try and break the inflationary spiral and, in our view, the lagged
impact of the all rate rises has a good chance of doing that. The RBI is
also correct to imply that the government hasn’t exactly pulled its
weight in helping control underlying inflationary pressures in recent
times.
By way of a footnote, the RBI also announced a deregulation of
the savings deposit interest rate. This follows on from the release of
a discussion paper on the subject that was published in April this year
and means that, with immediate effect, banks are free to determine
their own savings bank deposit rate with a couple of reasonably minor
conditions.
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