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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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.

RBI Monetary Policy Review: Policy Rates Unchanged, SLR Revised By 1%.

Reserve Bank of India’s latest monetary policy review has left the policy rates unchanged and the Statutory Liquidity Ratio has been revised by 1% to 25%.

Monetary Policy Action For A Sustainable Fragile Recovery

Reserve Bank India Headquarters in Mumbai.Over the past few months, the health of the global economies have been improved significantly however, the recent RBI’s monetary policy shows that the central bank is taking no chance for the sake of the economic growth as the RBI understands that the current economic recovery is fragile. Perhaps, the companies around the world are announcing better than expected quarterly results, but its not showing the real growth in revenue or on the bottom-line side, but actually it shows the positive response of cost cutting measures, which had been taken when the recession was at peak in Sep, 2008. Moreover, since the Indian economy decelerated in the last few quarters, Reserve Bank is taking permissive measures regardless the inflation problem which is persisting and would force the RBI in near future to take hawkish policy actions for a sustainable growth and to prevent the possible asset bubble, the same which was done by the former RBI Governor – Yaga Venugopal Reddy, who raised the interest rates even in difficult times to avert the Indian Banks from huge losses. To safeguard the economy from the rising public debt, the fiscal stimulus needs to be sustained until the recovery is on. Whether the economy is collapsing or recovering from the gorge, it is the crucial economic cycle and the sustainable recovery would be taken care of by way of stimulating the demand in a bleak times. In the recent economic research done by the VMW on the Indian Economy, in which we have mentioned about the disparity between the WPI and CPI inflation. The same is now concerning the central bank to decide over the interest rates which has been mentioned in the Minutes of Meeting (MoM) of the Board of Governors of RBI.

On Tue, 27th Oct 2009, RBI has left its key policy rates (Repo and Reverse Repo) unchanged for a while and hinted upon a high degree of probability of higher inflation in the near future which would be a turnaround for the interest rates. Moreover, the central bank emphasis on credit flows to the Agriculture and SME sector for a growth revival has disappointed the Real Estate industry. RBI has not even touched the Cash Reserve Ratio (CRR) as the liquidity in the market is still at a comfortable level. Upto first week of Oct 2009, M3 Money Supply was at 18.9 per cent above the RBI estimate as the large Government Borrowings reflecting the expansion of M3 Stock of Money.

Over the past few years, RBI’s monetary actions are always growth specific. India is a supply constrained economy as compare to developed economies which are lagging by lament demand. To supply the ample social infrastructure, RBI is now focussing on the Real Estate and Infrastructure sector. The stance of the Monetary Policy for the rest of the year 2009  under different monetary measures in which the Repo Rate and Reverse Repo rate has been leave unchange at 4.75%, and 3.25% respectively. CRR has also been retained unchanged at 5% while the SLR has been revised by 1 percentage point to 25%.

Developing Asia To Be Buoyant To The Global Downturn, Says Asian Development Bank.

Developing Economies in the Asian region would be more resilient to the global downturn than was initially thought, the major ADB report says.

A man talks on his cell phone past the electronic stock board of a securities firm in Tokyo, Japan, Friday, Aug. 14, 2009. Japan's Nikkei 225 stock average rose 80.14 points, or 0.8 percent, at 10,597.33, the highest close since Oct. 3. (AP Photo/Itsuo Inouye)Asian Development Bank on Tuesday has published its report on the Asian Region forecasting the economic growth for year 2009 and 2010 at 3.9% and 6.4% respectively. According to the ADB, despite the worsening economic situation, developing Asia is poised to lead the recovery from the worldwide slowdown. Active response from the government and healthy financial system in the region has fuelled the economic growth and insulated the region from the worst economic crisis to certain extent.

India Economy in particular, ADB has raised the growth forecast from 5 per cent to 6 per cent for the year 2009, and 7 per cent for the year 2010. The key drivers for Indian economy to survive is quicker than expected return on capital, huge capital inflows, increase public spending, Industrial production is improving, however the risk of downside in the economy due to weaker exports, weaker agriculture output expectations has been minimized by the way of announcing stimulus packages and monetary policies which has maintained the financial system in working condition, although the agriculture output is expected to revive by the last quarter. According to the ADB, 2010 would be better for the economy as the industrial economies is supposed to be out of recession, thus the exports will likely to turnaround and it will cut the overall trade deficit.

On the inflation side, as the food prices are soaring due to poor output of crops this year, the report suggest that the government will be able to contain the inflation by importing the appropriate amount of foodgrain, however it would create the chaotic situation for the central bank while coming on to the monetary policy review. Higher CPI would influence the RBI’s monetary decision and hence, the revision in interest rates is expected as the VMW had research earlier. Key valid points which has been outlined by the ADB to broader openness for the economic resilience:

  1. Reinforce Intra-Regional Trade.
  2. Effectively manage financial globalization.
  3. Maximizing the benefits from labor mobilization.

 

 

This report is officially published by the ADB and the content used in this post has been taken from the report of Asian Development Bank. VMW is not intended to disseminate this report and has been published on VMW Blog for the information purpose only for the visitors.