India’s Annual Monetary Policy 2011 – Inflation Is Expected To Remain High Amid Robust Economic Growth.

The thirst of robust economic expansion and higher commodity prices will technically push inflation on the upside and interest rate in India is expected to remain high for the next couple of fiscal years as the RBI seeming to keep interest rates on the higher side to maintain the cost of credit exorbitant to lessen the demand.

 

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It was the confrontational step of the Reserve Bank of India by revising another 50 bps in its policy rates to address the wild price rise situation in order to eliminate the risk of higher inflation and to persuade the Indian economy to grow fast but sustainably. VMW has analyzed the inflation problem from the household’s kitchen to the corporate decision maker and found that the food prices are not rising as fast as the non-food articles do, due to increase in international commodity prices. Food prices in March rose by 9.47 per cent while the prices of non-food articles rose by 25.88 per cent largely inflated by expensive crude oil and other important imported commodity products. So far, the effect of RBI’s rate tightening and expensive commodity prices – rallied on the economic euphoria – can be seen on the Capital Goods sector of India. India’s IIP index has been fluctuating, and the capital goods, index in particular, has performed deplorably (see figure below) due to higher cost of credit, tolling in the company’s income statement in terms of higher interest payments. Construction, Energy, Real Estate, Diversified and Infrastructure companies have piled up billions of dollars in terms of debt to function their operations and to execute their awarded projects.

 

The important wings of the Indian government and the Reserve Bank of India are expecting the inflation around 6 per cent by the end of the fiscal year 2012. However, the VMW’s estimates are bucking the government and RBI’s estimates – expecting the inflation to remain above 6 percent and even in a double digit by the end of this year (up to 11 percent). The only fundamental cause is the India’s hunger of economic expansion at a faster pace, and the same would not pull down the inflation to lower levels, since it will dramatically push the demand in the economy for pricey imported commodity. Moreover, the US Federal Reserves’ monetary expansion program, known by Quantitative Easing or QE2 is scheduled to end by Jun, 2011 and, perhaps, it will not reduce the impact of higher inflation in the economy right away and high supply of a dollar could depreciate it against the other major currencies, which will push the international commodity prices. The expensive imports will prevail upon the higher current account deficit until the export figures too remain blunt. Henceforth, the Current Account Deficit remains a prime concern for the economy. Although, RBI is not considering it as a major threat but the VMW is deliberating the same, and the prime predicament could be the lower portfolio investments since Foreign Institutional Investors’ flows (FII) are the immediate source of financing the Current Account Deficit and Foreign Direct Investments are not as easy as the FII flows are due to scores of roadblocks to the investments and instability in national politics and India’s foreign policy.

 

Inflation always Remained High in India and Now Needs Government Intervention Plus Tighter Monetary Policy from RBI’s Side. 

Now, in our research lab, we have analyzed the inflation problem. Look at the GDP Deflator and the WPI Inflation rate – how these trend lines have emerged over the past six fiscal years. GDP deflator is one of the other important tools to measure inflation, and it show, the inflation problem was relentlessly haunting the Indian economy. The most significant discovery is, the RBI loosened the policy rates during FY08, when India faced the condition of deflation due to change in the base year and was not reflecting the correct picture. However, GDP deflator remained at the alarming levels. At the same time, in FY09, RBI has raised the interest rates to prevent India to be a victim of the global financial crisis.

 

Here, we are not suggesting the RBI to track the GDP deflator, but to align its monetary policy to fix the “structured inflation problem”, caused by huge government borrowings, and at the same time, to make the economic growth sustainable and to refrain from the economic overheating. Plus to this, there is an urgent need of government intervention in terms of policies to overhaul the distribution of agricultural produce, to check the government borrowings and bringing down the fiscal deficit, which is now estimated at 5.6 percent until Feb, 2011 and 5.8 percent for FY2011. This will also subdue the prices.

 

 

Future of the Interest Rates in India

Rise in crude oil prices and other imported commodity price holes the Indian Economy up. It is one of the biggest risks to India since the country is not completely reliant on its own energy output and imports more than 70 percent of crude oil from GCC countries and other OPEC members. It’s expected that the global economic recovery would not stall but the pace will come down most importantly when the United States has stepped up its efforts to bring down the fiscal deficit to 4.1 percent by 2014. Nevertheless, the real economic output could remain under pressure due to the effect of increasing government debt. Since, we have focused on the final output (GDP) and it shows the prices of final produce in a particular financial year are increasing by more than 7.0 percent, whereas the WPI inflation is fluctuating throughout the discussed fiscal years. Provided herein is India’s stock of money or M3 for the last three fiscal years, which reverberates above 20 per cent. However, it is now falling significantly back to 15 per cent, and it shows the RBI’s action in policy rate is working, which means the monetary policy has a certain effect on the core inflation problem and would make an impact on the demand side but it is not sustainable as the government’s borrowing plans are on track.

 

 

 

 

Lower money supply has side effects too as it will increase the cost of credit further, and it will reduce the access to credit. Moreover, the stock markets could not function properly in this environment since the economic activity declines, which will eventually reduce the value of people’s retirement savings. However, the RBI has only one choice – tight monetary policy to tame inflation by giving up the India’s ambitions of double digit economic growth.

 

This VMW Research is originally published at UNIDOW.com

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RBI’s Annual Monetary Policy: RBI Revised Repo Rate And CRR. Policy Expected To Be Aggresive Amid High Inflation.

Grim economic outlook along with poor monsoon was the biggest concern last year, but for this year, inflation is the biggest challenge for the Reserve Bank of India.

  

Click here for the latest VMW Research on India’s Annual Monetary Policy

 

Reserve Bank of India on Apr 20, 2010 has revised its policy rates and CRR by 25 bps. In response to the intimidating supply side factors, India’s inflation dynamic economic growth – as the domestic balance of risk shifts from economic slowdown to inflation, RBI decided to absorb liquidity from the market to control prices. The recovery process in the global economy persists amidst the policy support around the world. In India, RBI has forecasted the GDP growth for 2009-10 at 7.5 per cent while the CSO has forecasted the GDP growth at 7.2 per cent and may settle down in between 7.2 and 7.5 per cent.

Challenges remain in the economy, just perturbing factor has shifted from the economic slowdown to the inflation. Today, inflation is the biggest challenge for the RBI. The headline inflation – measured on WPI on year over year basis, expedited from 0.5 per cent in Sep 2009 to 9.9 per cent in Mar 2010, exceeded the RBI’s baseline projection of 8.5 per cent. Since the economic environment evolving very rapidly, the demand for non-food items also hasten which is propping-up the inflation, thus it is clear WPI is no longer driven by the supply side factors alone.

Raising substantial amount of money for the central government and at the same time, curbing additional liquidity to control prices will be a biggest challenge for the Reserve Bank of India to manage borrowings of the government during 2010-11.

 

 

During 2009-10, the Central government borrowed Rs398,411 Crores ($87.3 Billion approx.) through the market borrowing programme such as Market Stabilization Scheme (MSS) and open Market operations (OMO). This large market borrowing by the government pushing up the yields on government securities during the last financial year, however the lower demand for the credit by the private sectors and better liquidity management by the central bank has cushioned the yields. Moreover, the Union Budget for 2010-11 has begun the process of fiscal consolidation. Government budgeting to pull down the fiscal deficit to 5.5 per cent of the total GDP as compare to 6.7 per cent in 2009-10.

What would be the Possible Causes for Further Elevation in headline Inflation?

  • Rise in Food as well as non-food articles as the prospect of monsoon is not yet clear.
  • Rise in commodity prices poses greater risk to the inflation such as wild volatility in crude oil prices.
  • Strong industrial output according to the IIP data shows the revived confidence in corporates and regaining their pricing power and building up of demand side pressure.

 

Initiating the fiscal consolidation process is a major positive development to enhance the monetary situation in the country as it aimed at reducing the government deficits. This will help avoid the unforeseen demand for private sector credit and would facilitate better monetary management. Nevertheless, the overall size of the government borrowing would exert pressure on the interest rates going forward.

After a series of monetary expansion during the financial crisis, Reserve Bank of India decided to curb liquidity by way of revising policy rates and CRR. In order to achieve the consolidating economic growth, RBI’s policy stance would be a meaningful step towards the resilient economic growth of the country despite the dubiety of rainfall, inflation is now become more generalized and no longer driven by supply side pressure and better liquidity management to make sure that government borrowing programme would not get hampered. In its latest monetary measures, RBI had the following  plan of action for managing liquidity:

Policy Rates as of Jun 2010
       
Repo Rate 5.25% 0.25
Reverse Repo Rate 3.75% 0.25
Bank Rate 6%   0
       
Reserve Ratios      
       
Cash Reserve Ratio 6% 0.25
Statutory Liquidity Ratio 25%   0

 

Please read the latest VMW Research on the RBI’s Monetary Policy at VMW Blog!

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(SA) RBI Revised Its Monetary Policy; Reduces Repo Rate & Reverse Repo Rate.

Reserve Bank of India modifies its monetary policy. RBI Governor Duvvuri Subbarao has slashed CRR and policy rates several time since he took the charge.
 
Banks are under significant liquidity pressure and it is evident that the banks are now withdrawing money under the central bank’s Liquidity Adjustment Facility (LAF) or Repurchase Agreement (Repo). Is the RBI cogitating the another rate hike to contain inflation under the compressed liquidity situation? Find out more.
The Reserve Bank of India.

The Reserve Bank of India Headquarters in Mumbai.

On Tuesday Apr 21, 2009, India’s Central bank – Reserve Bank of India has announced its Annual Policy on Macroeconomic and Monetary Developments. RBI has slashed its policy rates by 25 bps. BPS is Basis Points which should be defined by One Hundredth of a one percentage point 1/100th of 1%.

After the reduction in policy rates, RBI’s Repo rate stands at 4.75% and Reverse Repo rate stands at 3.25%. Repo means repurchase agreement in which banks sell government securities to the RBI in exchange for cash and agrees to repurchase those securities from the RBI at a later date which is the Reverse Repo Rate. While addressing to media, RBI Governor stresses that the bank should pass-on the reduction benefits to the consumers. India has witnessed the steep fall in demand for a credit.

RBI Reference Rate As on Apr 2009

Bank Rate 6%
Repo Rate 4.75%
Reverse Repo Rate 3.25%
Cash Reserve Ratio (CRR) 5%
Statutory Liquidity Ratio (SLR) 24%
Prime Lending Rate (PLR) 13%

 

The Indian Economy has also got affected by the economic crisis in developed countries. Since mid of Sep 2008, when the major financial institutions were collapsed, the India’s central bank has reduced its policy rates and CRR by number of times and SLR by 100 bps since than to prop the Indian economy up. India’s money supply dropped to 18.4% in compare to 21.7% last year which signifies the deceleration in credit market and the capital inflows. In the last few months, Indian Rupee has depreciated by more than 18%  and likely to depreciate further due to higher risk aversion in Rupee denominated assets, acute deleveraging due to falling exports which resulted fall in corporate earnings and strong demand for US Dollar due to huge amount of selling in equity markets. However, since Mar 09, financial markets have performed better in compare to its peers and other developed markets due to attracting and cheap valuation of the India Incorporated. By taking these factors in mind, RBI is taking precise decision on a periodic basis to respond to the global financial crisis and to make a favorable economic environment. India’s external debt and national debt has reached the level of 49% to the annual gross domestic product, however the strong foreign reserves would ensure the external stability. 

This research has been Superannuated by the VMW Research Team. This research might not be applicable in today’s economic context.

RBI Responding To The Economic Downturn, Cut Repo Rate And Reverse Repo Rate.

Day after day, we are witnessing the bad news coming from across the world. In the Year 2009, day by day, the condition of the global economy is deteriorating as the financial crisis has spilled over from a single continent to the across the globe. The effect of the global downturn can be felt in India too to a certain extent, perhaps the Indian authorities are responding on a timely basis to weather this horrific economic catastrophe. In response to that, India’s central bank – Reserve Bank of India (RBI) has further eases the monetary policy on Wed, Mar 4, 2009 by slashing policy rates by 50 bps with immediate effect.

RBI has reduced the Repo rate by 50 bps to 5.0% from 5.5% while there is also a reduction of 50 bps on reverse repo front by 50 bps to 3.5% from 4.0%. However the CRR remained untouched. According to the RBI, there is no need to reduce the Cash Reserve ratio as of now, but will be considered if needed. Since the Oct, 2008 RBI has reduced the policy rates, CRR and SLR by number of times in order to maintain the flexibility in the banking system and the functioning of the Financial Markets in an orderly manner.

VMW Definitions:

  • Repo Rate: is a rate at which, RBI repurchases Govt Securities from the commercial banks to expand the money supply in exchange of cash.
  • Reverse Repo Rate: Vice versa of Repo rate means to sell Gov’t bonds in exchange of cash.
  • CRR: is a Cash Reserve Ratio. Banks kept some portion of their deposits with the RBI at a prescribed reserve rate.
  • SLR: is the Statutory Liquidity Ratio at which banks need to kept short term securities such as Cash, Gov’t Securities, Precious Metals like Gold and Silver and other short term securities.
  • BPS: is Basis Points which should be defined by One Hundredth of a one percentage point (1/100th of 1%). It is commonly used in expressing differences of interest rates.

If you need further clarification on these Finance terms, send an email at contact@vishalmishra.com

RBI Cuts Policy Rates And CRR To Enable Banks To Provide Credit At Cheaper Rates Meanwhile, Govt Announced The 2nd Stimulus Package.

RBI cut Repo rate, Reverse Repo by 100 bps to 5.5% and 4% respectively on the other side, there is reduction of 50 bps on CRR to 5%. CRR cut to release Rs. 20,000.00 Crores ($4.08 billion) on the other side, Govt has announced the second stimulus package to defend the economy from the global downturn. Click here to read the latest RBI Action on Policy Rates.

Reserve Bank of IndiaAs the global financial situation is continue to exacerbate and the official announcement of Recession by the advanced economies like the United States, Japan and the Euro Zone; the Reserve Bank of India (India’s Central Bank) is aggressively responding to the crisis to maintain the sound banking system via adequate amount of liquidity and sustainable economic growth to achieve targets. on 2nd Jan 2009, RBI has cut Repo rate and Reverse Repo rate by 1 percentage point to 5.5% and 4% respectively and Cash Reserve Ratio (CRR) by 50 bps to 5%. Now, its assume that the reduction in policy rates and CRR of central bank would make possible for the banks to cut their lending rates in order to provide cheaper credit.  On the same day, Deputy Chairman of Planning Commission, Mr. Montek Singh Ahluwalia has also announced the second stimulus package to the Indian Economy to weather the global financial crises with success. The second stimulus package would allow the companies to borrow more from abroad through ECB and FIIs to invest more in the country. This package also gave attention to the Housing sector and Infrastructure sector by providing liquidity of Rs. 25,000.00 Crores ($5.21 billion) through investment grade papers. In order to encourage infrastructure projects in the country, Govt has allowed the India Infrastructure Finance Company (IIFC) to raise upto Rs. 10,000.00 Crores ($2.08 billion) through tax free bonds for refinancing the bank lending of longer maturity to eligible infrastructure bid based Public Private Partnership (PPP) projects. This will mainly enables to fund the projects like Highway and Port projects.

Apart from that, to protect the Micro, Small and Medium Entreprises (MSME) from the economic downturn, guarantee cover under Credit Guarantee Scheme have been extended from Rs. 50 Lakhs to Rs. 1 Crores with a guarantee cover of 50%.

VMW Definitions:

  • Repo Rate: is a rate at which, RBI repurchases Govt Securities from the commercial banks to expand the money supply in exchange of cash.
  • Reverse Repo Rate: Vice versa of Repo rate means to sell Gov’t bonds in exchange of cash.
  • CRR: is a Cash Reserve Ratio. Banks kept some portion of their deposits with the RBI at a prescribed reserve rate.
  • SLR: is the Statutory Liquidity Ratio at which banks need to kept short term securities such as Cash, Gov’t Securities, Precious Metals like Gold and Silver and other short term securities.
  • BPS: is Basis Points which should be define by One Hundredth of a one percentage point (1/100th of 1%). It is commonly used in expressing differences of interest rates.

If you need further clarifications on these Finance terms, send an email at contact@vishalmishra.com

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(SA) Economy In Crisis: What The Year 2009 Holds For India?

    

The Global Recession 2009.The Year 2008 was dreadful for the Global Economy. It started small in the mid of 2007 and then it went global. This Economic crisis which some Economists observing it analogous to the “Great Depression in 1930s”. This crisis has affected all of us by number of ways. hundreds of thousands of jobs has been lost so far and still counting. The deteriorating US, Japan and the Euro Zone Economy impelling the Indian economy on the downside. The other developing economies are also not immune to this global downturn. Fastest developing nation – China fears, their economic growth should fall to even below 6% from 11.4% in 2007. Global equity markets also fell heavily due to major slump in the financial sector. Indian Equity markets have lost half of its total value since Jan, 2008 peak while the other major markets fell between 35% and 72% and still there is no signs of recovery in the global financial markets as the economic situation is continue to worsen. The recent Macro economic data from the United States shows the further deepening of Recession. Falling demand for crude oil lead to steepest fall and now trading at 4 year lowest levels.   

India’s Economic Story   

Inflation Rate in 2008

General Trend: Inflation Rate in 2008

Developing economies like Brazil, Russia, India and China (BRIC) are emerging as an economic powerhouse.  Since the year 2002, Indian Economy grew at an average rate of over 8%. The recent Financial Tsunami which led to the severe recession are also affecting the developing nations. Some of the major economic factors are now in favor of the Indian Economy. One of the vital positive changes are cooling inflation (see the picture on the left side, showing the Inflation trend), commodity prices, Crude oil prices, falling interest rates. RBI still have a lot of room to ease its policy rates further when the inflation below 1%. In the Year 2008, RBI had revised its key rates several times to maintain the liquidity in the banking system. The lower interest rates will allow the banks to cut their benchmark lending rates, though the deposits will also see the reduction in interest rates. Lower commodity prices and crude oil prices is driving the Inflation on a downside.  Lower inflation means, lower cost of credit, which drives the economy on the upside, however in first half of 2009 (H1-09), growth will slow significantly as Industrial production suffers from lower exports. (see the given below picture showing the IIP trend in FY2008).   

IIP Growth in FY2008-09

General Trend: IIP Growth in FY2008-09

The recent economic indicators – Index of Industrial Production (IIP) data showed the negative growth of the economy, the another negative point for the Indian economy is rising fiscal deficit. Fiscal deficit estimated at over 8% of the India’s annual gross domestic product (GDP) (see our latest Post: “Interim Budget 2009 Review” for more information) and 3rd Quarter Advance Tax data which is fell by 22% over the corresponding year. It shows that the profitability of the Indian corporate is lessening. The fact is, “we’re now in the middle of the Global Recession” and we’ll see some more drastic changes in the global economy. Besides these factors, other important factors are falling demand for Indian exports and depreciating Rupee which will widen the Current Account deficit is another cause of concern. India’s largest import product is Crude Oil and weaker domestic currency would make imports dearer, however the weaker currency will lead to higher demand for India’s exports, but as mentioned earlier, the global recession have a drastic impact on India too.   

What To Watch Out For   

  • Headline Inflation will continue to fall and some economies (particularly developed one) will see short period of Headline Deflation in H1 of 2009. Reason: rapidly falling inflation, asset prices, and credit crisis. 
  • Central banks in across the world will continue to ease their monetary policy in the next three to six months to impede the deeper downturn and the risk deflation outcome.
  • FY09 earnings in India and 1st quarter earnings in the US and Europe. Bank’s result would be the top priority for the global investors as their positive corporate earnings might be an advance indicator for an improvement in the credit market and whole banking system which has a lead role to damage the global economy.

In the coming three to six months, the economies are expected to continue to contract as the negative impact from the credit crisis, a further deepening of the housing slowdown, a backlash in Emerging Markets. The 1st Half of year 2009 is very crucial and by mid-2009, economies are expected to return to positive growth rates and a subsequent slow recovery will materialize during H2 next year. The US would be the first to recover followed by Asia. The positive effects from falling energy prices, monetary policy easing, and fiscal stimuli will definitely work.   

The Reason For Recovery In H2 2009    

  • First of all, the falling Crude Oil prices from almost $150 a barrel to below $50 a barrel. Higher commodity prices were the main driver for the economic downturn last year. Food and raw material prices followed suit push the inflation on the downside. The lower inflation will act as a tax relief significantly supporting consumer purchasing power during the coming months.
  • Further widespread easing of Monetary Policy. US Central Banker, Federal Reserve will implement the Zero Interest Rate Policy (ZIRP) in its Jan, 2009 meeting. European Central Bank (ECB), the central bank of Euro Zone will likely to cut aggressively. This will lead to fade in credit crisis and the economy will start to recover.

Forecast For India   

VMW expects, India to grow at 6.2% in FY09 and 6.1% in FY10. On the RBI policy front, RBI should cut interest rates further to fuel the economic growth; however the robust Foreign Exchange Reserves and the strong domestic demand will protect the Indian Economy from sharp downfall.   

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This VMW Research is Marked as “Superannuated” by the VMW Research Team and the content of this research is no longer in use in today’s economic context, however certain references and inferences in this research can be use.

RBI Cut Repo Rate And Reverse Repo Rate by 100 BPS To 6.5% and 5% Respectively.

No change in Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). Banks are reluctant to cut rates despite the RBI’s rate cut move.

Most of the bank’s Prime Lending Rate is still hovering between 12% and 16% despite the RBI’s effort to ease the interest rates for the economic growth. In the wake of recent Mumbai attacks which hurt the investors’ sentiment, and the day after the RBI’s rate cut announcement, the Indian Government also announced the $4 billion (Rs. 20,000 Crore) fiscal stimulus package to impede the slowing economic growth. This stimulus package particularly announced for supporting the India’s Small and Medium Entreprises (SMEs) in order to protect them from falling demand of their products in international markets as the consumer cut back their spendings in a recessionary economy. Major support by the government comes to the ailing Textile Sector. Many small textile companies have already shut their operations due to cash shortages (working capital) to run daily operations.

The recent GDP data was not surprising and not even so attractive. The growth at 7.1% was already anticipated however, the GDP growth could tumble further to the lower than that levels. Although, recent move by the Govt. and the RBI will strenghten the economic efficiency, but still RBI needs to respond to further economic developments over the period of time. We’re expecting the more rate cut and even CRR cut from the RBI side and may likely to cut both Repo Rate and Reverse Repo rate in the next few months. Even we can see the CRR cut to increase liquidity in the banking system if required.

The recent rate cut announcement by RBI on 2nd Jan 2009. Click here to find out.