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Hawkish RBI surprises with 50 bp hike
RBI hiked the repo and reverse repo rate by 50 bp today; above consensus
expectations of 25 bp. Inflation continues to be its dominant macroeconomic
concern.
RBI hiked policy rates by a surprise 50 bp
! The RBI earlier today in its mid-quarter monetary policy review for July hiked both the repo
rate (to 8.0%) and the reverse repo rate (to 7.0%) by 50 bp. This hike was a significant
surprise to RBS and consensus expectations of 25 bp. Though the RBI had signalled a
continuation of its tight monetary stance in its macroeconomic review yesterday (refer "RBI to
continue anti-inflationary stance" dated 25 July 2011 for details), today's 50 bp hike genuinely
surprised the market as suggested by the decline in both equity and bond prices.
! The surprise stems from RBI's desire to maintain its credibility of commitment of monetary
policy to maintain inflation, thereby keeping medium term inflation expectations anchored.
The RBI also wanted to reinforce the point that in the absence of complementary policy
responses on both demand and supply sides, stronger monetary policy actions are required.
! The RBI has now hiked the effective policy rate by a cumulative 475 bp since the tightening
cycle began in March 2010 - one of the sharpest monetary tightening seen across the world
by the RBI's own admission.
Hawkish stance suggests inflation data to drive policy actions
! The RBI expects GDP growth to stay around trend growth of around 8%, and does not see
any evidence of a sharp or broad-based slowdown yet. Exports and imports, indirect tax
collections, corporate sales and earnings and bank credit demand suggest to the RBI that
demand is moderating but only gradually. Despite the industrial production growth slowdown
and the reduction in corporate pricing power, the RBI continues to be concerned by
persistently high inflation and its expected slow decline. The RBI acknowledged that early
corporate results for the June quarter suggest some moderation in margins (and hence
pricing power). However, it feels such moderation has been modest, implying that pricing
power persists.
! Per the RBI, the monetary policy stance will depend on the evolving inflation trajectory. A
change in stance will be motivated by signs of a sustainable downturn in inflation, with
particular focus on the behaviour of the non-food manufacturing component (i.e., core
manufacturing inflation). This suggests that the RBI will wait for yoy core manufacturing
inflation to subside prior to relaxing its monetary stance. Going forward, because of the base
effect, yoy core manufacturing inflation could stay high (i.e., higher than 7%) through
December, even if seasonally adjusted trends post August are close to the RBI's comfort
range of 4%.
! The next mid-quarter review of Monetary Policy is scheduled for 16 September 2011, while
the Second Quarter Review is scheduled for October 25, 2011. We think it is unlikely that yoy
core manufacturing inflation will trend down significantly before then.
! As such, we think the RBI could hike the policy rate by another 25-50 bp over these next two
meetings before finally concluding its monetary tightening cycle. In RBI's prior tightening
cycle, the repo rate peaked at 9% in July 2008. The RBI's scheduled analyst interaction
tomorrow should provide more visibility on the policy rate path.
RBI's macro outlook; inflation forecast raised to 7%
! As mentioned earlier, the RBI has maintained its FY12 GDP growth forecast of 12%. 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".
! However, it has raised its March 2011 yoy WPI inflation forecast to 7% from 6%, with yoy
inflation expected to start trending down post September 2011 (as such, the projected
inflation trajectory is similar to what was laid out in the 3 May policy statement).
! The RBI expects the inflation outlook will be shaped by a) overall performance of the southwest monsoon, b) crude oil prices, c) suppressed inflation in the economy linked to subsidized
retail fuel prices and administered electricity prices.
! The RBI has revised downwards its M3 growth projection for FY12 to 15.5% from 16.0%, and
non-food bank credit growth projection to 18.0% from 19.0%.
! RBI's lists the following risk factors to its indicative FY 12 growth and inflation projections a)
global commodity prices, b) capital flows and their composition, c) food inflation risks due to
weak monsoon and higher minimum support prices, and d) fiscal deficit slippage.
Could the RBI be tightening too much?
! The RBI's anti-inflationary stance is based on the premise (and rightly so) that high inflation is
inimical to long-term growth. We think the RBI does feel handicapped in its quest to control
inflation given relatively loose fiscal policy, and the lack of investments in a supply side
response to increasing demand (especially agriculture and infrastructure).
! However, we do think that the RBI may end up tightening too much if it continues with its
current anti-inflationary stance. Firstly, we think the RBI's focus on yoy trends in core
manufacturing inflation (which would be impacted by the base effect) belies the fact that
seasonally adjusted core manufacturing inflation may have already peaked in
February/March. Data in the RBI's macroeconomic review also supports this conclusion.
Second, the RBI specifically pointed out in its macroeconomic review that real lending rates in
the economy are in positive territory, and that investment activity is slowing. It also sees the
need for a pick up in investment to sustain the growth momentum. However, raising policy
rates further could impact negatively impact the already weak investment momentum in our
view. The RBI however believes that better execution can more than offset the impact of
higher rates.
Staying bullish markets though rate peak catalyst seems pushed out
! The RBI's continued hawkish stance suggests that policy rates will peak later than our earlier
expectation. That said, we continue to be buyers of Indian equities because of fair valuations,
a pick up in the government's reforms momentum, and our view that interest rates are close
to peaking out (though the policy rate peak has been pushed out versus our earlier
expectation). In hindsight, the overweight position in interest rate sensitive stocks (wholesale
funded banks and financial institutions and autos) in our model portfolio does seem a bit
premature given the continuation of RBI's anti-inflationary stance. However, we are continuing
with this stance, as valuations in many instances do suggest that a lot of bad news is in the
price.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Hawkish RBI surprises with 50 bp hike
RBI hiked the repo and reverse repo rate by 50 bp today; above consensus
expectations of 25 bp. Inflation continues to be its dominant macroeconomic
concern.
RBI hiked policy rates by a surprise 50 bp
! The RBI earlier today in its mid-quarter monetary policy review for July hiked both the repo
rate (to 8.0%) and the reverse repo rate (to 7.0%) by 50 bp. This hike was a significant
surprise to RBS and consensus expectations of 25 bp. Though the RBI had signalled a
continuation of its tight monetary stance in its macroeconomic review yesterday (refer "RBI to
continue anti-inflationary stance" dated 25 July 2011 for details), today's 50 bp hike genuinely
surprised the market as suggested by the decline in both equity and bond prices.
! The surprise stems from RBI's desire to maintain its credibility of commitment of monetary
policy to maintain inflation, thereby keeping medium term inflation expectations anchored.
The RBI also wanted to reinforce the point that in the absence of complementary policy
responses on both demand and supply sides, stronger monetary policy actions are required.
! The RBI has now hiked the effective policy rate by a cumulative 475 bp since the tightening
cycle began in March 2010 - one of the sharpest monetary tightening seen across the world
by the RBI's own admission.
Hawkish stance suggests inflation data to drive policy actions
! The RBI expects GDP growth to stay around trend growth of around 8%, and does not see
any evidence of a sharp or broad-based slowdown yet. Exports and imports, indirect tax
collections, corporate sales and earnings and bank credit demand suggest to the RBI that
demand is moderating but only gradually. Despite the industrial production growth slowdown
and the reduction in corporate pricing power, the RBI continues to be concerned by
persistently high inflation and its expected slow decline. The RBI acknowledged that early
corporate results for the June quarter suggest some moderation in margins (and hence
pricing power). However, it feels such moderation has been modest, implying that pricing
power persists.
! Per the RBI, the monetary policy stance will depend on the evolving inflation trajectory. A
change in stance will be motivated by signs of a sustainable downturn in inflation, with
particular focus on the behaviour of the non-food manufacturing component (i.e., core
manufacturing inflation). This suggests that the RBI will wait for yoy core manufacturing
inflation to subside prior to relaxing its monetary stance. Going forward, because of the base
effect, yoy core manufacturing inflation could stay high (i.e., higher than 7%) through
December, even if seasonally adjusted trends post August are close to the RBI's comfort
range of 4%.
! The next mid-quarter review of Monetary Policy is scheduled for 16 September 2011, while
the Second Quarter Review is scheduled for October 25, 2011. We think it is unlikely that yoy
core manufacturing inflation will trend down significantly before then.
! As such, we think the RBI could hike the policy rate by another 25-50 bp over these next two
meetings before finally concluding its monetary tightening cycle. In RBI's prior tightening
cycle, the repo rate peaked at 9% in July 2008. The RBI's scheduled analyst interaction
tomorrow should provide more visibility on the policy rate path.
RBI's macro outlook; inflation forecast raised to 7%
! As mentioned earlier, the RBI has maintained its FY12 GDP growth forecast of 12%. 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".
! However, it has raised its March 2011 yoy WPI inflation forecast to 7% from 6%, with yoy
inflation expected to start trending down post September 2011 (as such, the projected
inflation trajectory is similar to what was laid out in the 3 May policy statement).
! The RBI expects the inflation outlook will be shaped by a) overall performance of the southwest monsoon, b) crude oil prices, c) suppressed inflation in the economy linked to subsidized
retail fuel prices and administered electricity prices.
! The RBI has revised downwards its M3 growth projection for FY12 to 15.5% from 16.0%, and
non-food bank credit growth projection to 18.0% from 19.0%.
! RBI's lists the following risk factors to its indicative FY 12 growth and inflation projections a)
global commodity prices, b) capital flows and their composition, c) food inflation risks due to
weak monsoon and higher minimum support prices, and d) fiscal deficit slippage.
Could the RBI be tightening too much?
! The RBI's anti-inflationary stance is based on the premise (and rightly so) that high inflation is
inimical to long-term growth. We think the RBI does feel handicapped in its quest to control
inflation given relatively loose fiscal policy, and the lack of investments in a supply side
response to increasing demand (especially agriculture and infrastructure).
! However, we do think that the RBI may end up tightening too much if it continues with its
current anti-inflationary stance. Firstly, we think the RBI's focus on yoy trends in core
manufacturing inflation (which would be impacted by the base effect) belies the fact that
seasonally adjusted core manufacturing inflation may have already peaked in
February/March. Data in the RBI's macroeconomic review also supports this conclusion.
Second, the RBI specifically pointed out in its macroeconomic review that real lending rates in
the economy are in positive territory, and that investment activity is slowing. It also sees the
need for a pick up in investment to sustain the growth momentum. However, raising policy
rates further could impact negatively impact the already weak investment momentum in our
view. The RBI however believes that better execution can more than offset the impact of
higher rates.
Staying bullish markets though rate peak catalyst seems pushed out
! The RBI's continued hawkish stance suggests that policy rates will peak later than our earlier
expectation. That said, we continue to be buyers of Indian equities because of fair valuations,
a pick up in the government's reforms momentum, and our view that interest rates are close
to peaking out (though the policy rate peak has been pushed out versus our earlier
expectation). In hindsight, the overweight position in interest rate sensitive stocks (wholesale
funded banks and financial institutions and autos) in our model portfolio does seem a bit
premature given the continuation of RBI's anti-inflationary stance. However, we are continuing
with this stance, as valuations in many instances do suggest that a lot of bad news is in the
price.
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