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UBS Investment Research
Asian Economic Comment
India: Finishing the medicine
What happened: The central bank (RBI) hiked policy rates by 25bp
(official repo at 6.5%, reverse repo at 5.5%). Basic reasons cited for
coming off 'pause': (i) higher inflation pressures which may start to be
reflected by high credit growth, (ii) higher global/regional commodity
prices (food and fuel), (iii) robust real GDP growth back up close to 9%
(stronger demand), (iv) an improved global situation (which could draw
capital back to OECD). RBI also raised its inflation projection to 7% in
March (in line with UBS) from 5.5%, but non-food credit growth and
M3 growth projections remain at 17% and 20% respectively.
What it means: In effect this rate hike validates the tight monetary
conditions already in place. Money market yields have been higher than
policy rates (and remain so) for three main reasons: (i) bank lending has
zoomed ahead of money supply and is running up against bank balance
sheet restraints, (ii) a wider current a/c deficit (up to 3.7% of GDP in
H1), (iii) higher inflation expectations (mainly keying off recent
commodity/oil prices moves). Chart 2 gives a crude WPI outlook under
various oil price scenarios.
Slowdown ahead: We expect these tight credit conditions in FY2011-
12 to result in slower bank lending (towards 18%) and slower economic
growth (down 1% to 8%). From a macro-angle ultimately this is a
benign result, but from a short term markets angle it may not seem this
way. The problem of today is if oil prices edge upwards the central bank
is put in a position where it must keep hiking policy rates to limit the
current a/c deficit and higher inflation expectations. To do this would
also require keeping the currency stable. In other words credit
conditions stay tight. This is the mechanism by which economic growth
slows. Currently, we have a benign outlook for oil prices (sub-$100 bbl)
and we expect 7.5% WPI by 2011-12 FY-end, which implies the RBI is
close to the end of interest rate hikes. We expect another 25bp hike in
FY20011-12. Once bank lending slows, the impetus behind further rate
hikes could fade, but for now the job is not quite finished.
We adjust our longer term (1 & 2 yr) exchange rate projection due to
prospects for higher oil-induced inflation alongside a slowdown in
economic growth. In essence, this year we now see a pause in the
appreciation story. For CY 2011 year-end we reset the INR/USD to 46
and for CY 2012 year-end reset to 41 (ie a minor 2.5% depreciation this
year with a resumption in appreciation next year).
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Asian Economic Comment
India: Finishing the medicine
What happened: The central bank (RBI) hiked policy rates by 25bp
(official repo at 6.5%, reverse repo at 5.5%). Basic reasons cited for
coming off 'pause': (i) higher inflation pressures which may start to be
reflected by high credit growth, (ii) higher global/regional commodity
prices (food and fuel), (iii) robust real GDP growth back up close to 9%
(stronger demand), (iv) an improved global situation (which could draw
capital back to OECD). RBI also raised its inflation projection to 7% in
March (in line with UBS) from 5.5%, but non-food credit growth and
M3 growth projections remain at 17% and 20% respectively.
What it means: In effect this rate hike validates the tight monetary
conditions already in place. Money market yields have been higher than
policy rates (and remain so) for three main reasons: (i) bank lending has
zoomed ahead of money supply and is running up against bank balance
sheet restraints, (ii) a wider current a/c deficit (up to 3.7% of GDP in
H1), (iii) higher inflation expectations (mainly keying off recent
commodity/oil prices moves). Chart 2 gives a crude WPI outlook under
various oil price scenarios.
Slowdown ahead: We expect these tight credit conditions in FY2011-
12 to result in slower bank lending (towards 18%) and slower economic
growth (down 1% to 8%). From a macro-angle ultimately this is a
benign result, but from a short term markets angle it may not seem this
way. The problem of today is if oil prices edge upwards the central bank
is put in a position where it must keep hiking policy rates to limit the
current a/c deficit and higher inflation expectations. To do this would
also require keeping the currency stable. In other words credit
conditions stay tight. This is the mechanism by which economic growth
slows. Currently, we have a benign outlook for oil prices (sub-$100 bbl)
and we expect 7.5% WPI by 2011-12 FY-end, which implies the RBI is
close to the end of interest rate hikes. We expect another 25bp hike in
FY20011-12. Once bank lending slows, the impetus behind further rate
hikes could fade, but for now the job is not quite finished.
We adjust our longer term (1 & 2 yr) exchange rate projection due to
prospects for higher oil-induced inflation alongside a slowdown in
economic growth. In essence, this year we now see a pause in the
appreciation story. For CY 2011 year-end we reset the INR/USD to 46
and for CY 2012 year-end reset to 41 (ie a minor 2.5% depreciation this
year with a resumption in appreciation next year).
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