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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RBI’s Third Quarter Monetary Policy. CRR Raised By 75 Bps.

India’s Central Bank, Reserve Bank of India (RBI) announced its Monetary Policy on Fri, Jan 29, 2010 and decided to raise CRR by 75 bps to 5.75%.

As expected, Central bank, Reserve Bank of India has raised Cash Reserve Ratio (CRR) by 75 bps to 5.75% and keeps its policy rates unchanged as per the expectations of VMW, however the hike in CRR is well above, what we had anticipated. While the global economy is stabilizing, the growth outlook has been revised. Economies have rebounded steadly after the significant government intervention. Over the past two years, RBI has reduced the policy rates and CRR in response to the economic crisis to infuse the sufficient amount of liquidity into the market to emerge from the dried liquidity situation and to provide the ample credit facility to the economy to impede the greater risk of economic trouble for the second fastest growing economy in the world. The general trend of CRR (shown below), shows, how the central bank has responded to the economic trouble. During the reign of YV Reddy, CRR jumped to 9 per cent in Aug 2008 just before the bankruptcy of Lehman Brothers to absorb the additional liquidity in order to prevent the Indian companies (banks & companies) to invest outside into the risky assets.

 

After few days, Duvvuri Subbarao has taken over the charge of RBI and he decided to reduce interest rates by more than 400 bps, when the financial crisis was at peak. Overall, the RBI has predominantly managed the situation mightily and helped the Indian companies to grow even in a gloomy economic period to a certain extent. Now this time, RBI raised the CRR as the Inflation rate is again at the alarming levels. India’s spiralling money supply over the past few months has grew by more than 22 per cent which is again the another matter of concern, which the RBI is taking it seriously to contain the the rise in prices. Rise in CRR would not likely affect the cost of borrowing as the banks are sitting on ample liquidity and shifting to the demand deposits to reduce their cost. Bank’s CASA , Time Deposit ratio has been shifted very aggresively post economic recession to reduce their cost. However, over the next few quarters, RBI may hike the Repo rate and Reverse Repo rate if the inflationary pressure continues.

India Budget 2009 Review. Market Expectations Despaired.

 

 

GDP Growth

IIP Data

Budget for an Inclusive Growth

Much awaited Budget mainly for reforms, hike in FDI limit financial industry, deliverance of an inclusive growth in the ecocomy were finally delivered by the Finance Minister of India, Pranab Mukherjee. Some of us were very happy with the proposals made in the House while other got disappointment on various front. For sure, India’s economic growth has been impacted by the global economic problems and the recovery in the western economy specially in the US would play a critical role in a growth of the Indian economy. The rising fiscal deficit, expenditures are not only a single major concern for the economy but the significant rise in government borrowings also does matter for the future growth, which would affect the borrowing cost (refer to the given below figure).

India's Fiscal Deficit for FY 2008-09 of Annual GDP at Current Market Price.

India's Fiscal Deficit for FY 2008-09 of Annual GDP at Current Market Price.

 

There is no doubt that the debt level of the Indian Government likely to puff up due to higher spending. First look at the brief synopsis of Budget 2009.

  • Mr Finance Minister has agreed upon the real challenges to get back to sustainable 9% GDP growth.
  • Finance Minister stressed upon infrastructure development by providing long term financial assitance to infrastruture projects via India Infrastruture Finance Company Ltd (IIFCL).
  • Increases allocations for National Highway and Railways projects.
  • Extension of repayment period from Jun 2009 to Dec 2009 under the Debt relief Program 2008 to the farmers having acquired land more than two hectares.
  • Gov’t of India commitment on restoring growth in export sector.
  • To Initiate Institutional Reform measures from this year to fix the rising Fiscal Deficit.
  • To allocate Rs 39,400 crores ($8.16 Billion) to National Rural Employment Guarantee Scheme (NREGS).
  • Total expenditure of Rs. 1,020,838 Crores ($209.62 Billion) according to the Budget Estimates 2009-10.
  • Abolishment of Fringe Benefit Tax (FBT) and removal of Surcharge on Income Tax.
  • Changes in Direct Tax Code.
  • Implementation of Goods and Service Tax (GST) from 1st Apr 2010.
  • Revision in Minimum Alternate Tax (MAT) from 10% to 15%.

Since the inflation is no longer a concern for the economic growth, India needs to opt for a better policies and reforms to achieve the macroeconomic stability. Interest rates become more stable backed by the comfortable liquidity situation in the system which would be prudent for the constant growth of the economy and to be self reliant driven by the domestic demand. Forasmuch, India seeing the higher non plan spendings due to Subsidy burden, Sixth Central Pay Commission, and food subsidy which would be a troublesome for the government to restructure its finances. Savings rate at 59% of the anual GDP and massive foreign reserves assets will put the Indian ecconomy on reposeful position in the global arena (helps the Indian economy to abstain from the risk of revision in credit rating).

Finance Minister Mukherjee has commended the budget without giving further stress on the spending and even didn’t touch the revenue side largely in the wake of the macroeconomic health. Foreign Inflows will continue to drive the Indian economy higher in future but the lower exports will make the Balance of Payments (BOP) uneasy for the economy. The vast current account deficit will make the Indian currency more vulnerable in the near term against the US Dollar however it would be a short term pain and not a major concern to think upon. We’re expecting some bit of reduction in fiscal deficit in FY2009-10 due to diminution in subsidy burden including Oil bonds, food subsidy and we could see the beginning of economic reforms in the fiscal year 2009-10 Budget.

We would discuss more in our next report “Indian Economy in 2009-10 Overview”