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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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.

(SA) Indian Economy 2009-10 Overview. Development in Economy Subsequent To The Recent Crisis.

High interest rates, inflation rate, trade deficit, fiscal deficit and depreciation of Rupee is expected in the next few months.

 

Recovery in Economy.VMW have researched on the global economy with the projection of contraction in the economy is expected in the first half of the year and will likely to see expansion in some of the economies. Germany and France, the largest and second largest economies of the European Union respectively and Japan, the largest economy of Asia has emerged from the recession after 5 quarters, and the United States is somewhat shy to come out of the recession and is expected to expand by the end of this year. The main drivers which might helped the economy, is the active response by the Government Authorities, in a way of announcing trillions of dollars in stimulus packages. Central banks around the world have poured in billions of dollars into the system to make credit market works and slashed interest rates to almost nil to impede the economy to go into deeper recession. With most of the indicators are now offering the sign of strength, however the wobbling unemployment and unsustainable government support to the economy would hamper the growth process. Amid the bleak environment in the global economy, GDP growth in developing economies are shrugging the outlook of their economic growth. With most of the economies were in melancholy, economies like India and China registered a growth rate of 6.7% and 9% respectively.

The immediate effect of the rebound in the global economy could be seen in the financial markets which have posted the spectacular gains in a short time. Since 2008 fallout, markets in India have been stabilized followed by the unprecedented victory in the recent elections, announcement of stimulus packages, and active response to the crisis by the central bank (RBI) which boosted market sentiment and anticipating greater reforms in the economy. In fact situation at the world level are also improving significantly. US economy in particular has offered strong signs of improvement in its economy and expunging the recession which begun in the last quarter of the year 2007.

India Economy Overview

In the above Chart, which is showing the India’s IIP, Inflation, Exports and Imports from Apr 2008 to Jun 2009. All trend lines are showing the sign of stability from falling which was started in 2008. Over the last six years, Indian Economy grew at an average rate of 8%, becomes one of the world’s largest economy. In 2007-08, Indian Economy posted a growth rate of 9%, though the economic growth has slumped due to recession in the west for the year 2008-09. Service sector will continue to outnumber the manufacturing sector and account for more than 53% of the total GDP, but still less than the advanced economies. According to the GDP data, IT export is on the rise and outpacing the overall growth of the sector.

Nasty Monsoon: This year’s deficient monsoon probably downgrade the overall economic growth as the Agriculture sector accounts for more than 18% of the total GDP. Uttar Pradesh, Andhra Pradesh, West Bengal, Punjab, and Haryana are the key farming locations of India. Almost scanty monsoon in Uttar Pradesh in particular will make a larger impact on India’s farm sector as the poor harvesting of Rice and Cane hit hard due to poor monsoon. Monsoon below average will make several kind of impact on India and other parts of the world. As India is the second largest producer of Rice and Sugarcane followed by the US and Brazil respectively, the commodity prices will go up, and according to the NYMEX data, the sugar prices soared by 62% since last year due to bad weather in India and the world had been affected by the food price crisis last year due to several reasons including poor harvesting due to drought situation and various other non-farm reasons.

Primarily, capital inflows into India has supported the sharp “V” shape recovery in the BSE’s benchmark index, Sensex. Indian equity markets perked up by more than 90% from its March 2009 lows (See given below figure). Foreign investments, positive growth outlook, consumer confidence, good corporate earnings, better reforms prospect might be a specific reason of overall growth in the financial markets. But, will the rally be sustainable over the next few months as the economy would not be grown as fast as we had expected earlier?

The global financial markets are trading at a reasonable value after sharp fall from the 2007 highs. From the beginning of this year, lot of money has poured into the markets around the world as the investors are optimistic about the economy. Developed economies would take more than two years to recover however the Asian economies will lead the overall economic recovery. Companies around the world has posted better than expected earnings in the last couple of quarters and showing the signs of recovery in their operations, nevertheless the growth in their earnings was ushered by cost cutting measures such as layoff and restructuring of their businesses. In general, their growth would be sustainable once the consumer confidence revives in the developed economies.

BSE Sensex

Unruly Supply-Side: Over the next few months, we will see the higher inflation due to supply side exertion. Supply side concern may include shortage of food grains, higher stock of money in the system due to spiralling government borrowings will doubtlessly push inflation on the higher side. We will expect the monetary action from Reserve Bank of India (RBI) in response to the microeconomic developments. Over the next few months, perhaps the Interest rates would go up in response to inoculate the economy from the risk of higher inflation and currency depreciation.

Economy in 2009-10: It would be bewilder that when we should expect the veritable recovery in the Indian Economy? Of course the Indian economy is not an exception and will go inline with the global economies. It will take a lot of time to recover however the situation has improved significantly and so far we have seen an extremely rapid movement in the economy. Moreover, the G-20 Summit, Pittsburgh in Sep 2009 will play a crucial role in the overall economic recovery as the global leaders were committed to monitor the situation and decision which were taken in G-20 Summit, London. However, we cannot expect the fresh stimulus packages from the Government Authorities to revive the economy.

Important Notice: VMW Research Team has marked this research as “Superannuated” 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.  Continue reading

(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.

(SA) Interim Budget 2009 Review: Fiscal Deficit Swells to 8% to the GDP.

Please Read the latest report on India Budget 2009.
India’s Fiscal Deficit swells to 8 per cent of the annual gross domestic product, govt spending likely to rise and tax rate cut are less likely. However, Govt has reduced Excise Duty and Service Tax to shore-up the economy.
 
 
Pranab Mukherjee

India's External Affairs Minister (Foreign Minister)

 

Then Minister of External Affairs – Mr Pranab Mukherjee, who was in charge for Finance Ministry also for a while, has announced the Pre-Election Interim Budget 2009 for the Fiscal 2009-10. Markets and the corporate world has anticipated lot of changes and reframing of policies to weather the current global economic downturn however, the Interim Budget has banished all the factors to support the Indian economy. Interestingly, he has pointed out that the major policy announcement would take place post election in the Regular announcement of the General Budget which was held in May, 2009. 

In his budget speech, he merely stressed upon the Rural Development by expanding the Rural Infrastructure Development Fund (RIDF) from Rs. 5,500 Crores ($1.13 Billion) for the year 2003-04 to Rs. 14,000 Crores ($2.87 Billion) for the year 2008-09. Apart from that, he has discussed, exactly what the UPA Govt have did in the last 5 years of their tenure. On the most important Financial and Tax reforms front, he has left this portion for the Regular Budget announcement. He said the, tax rates must fall in these stressful economic times, while the majority of industry has expected positive changes on the tax front and the ailing Real Estate and Infrastructure sectors had anticipated for support from the Government. Now, the RBI is the final ray of hope until the General Elections in a way of reduction in policy rates by at least 100 bps. 

India’s Finances 

Since the last Year’s Budget announcement, the Indian Govt’s finances have totally shaken up. Three major developments like provision for pay revision (Sixth Pay Commission), loan waiver and finally National Rural Employment Guarantee Act (NREGA) and various other subsidies has led to significant intensification of the India’s Fiscal Deficit. Initially, Govt had pegged it at 2.1% of the India’s GDP. This Fiscal Deficit has to be rise for sure as the Govt has announced two different Stimulus Packages in the last couple of months to stimulate the economy and the domestic demand, extra spending under NREGA, Subsidy on Oil and Fertilisers and most importantly the lower revenue/receipt from Taxes. Government is also expecting lower tax revenue in this fiscal year due to global economic downturn. The abstract of “Demand for Grant” is given below:  

  • Pay & Pension Revision: Rs. 28,505 Crores ($5.85 Billion)
  • Oil Subsidy (Oil Bonds): Rs. 65,942 Crores ($13.54 Billion)
  • Fertilizer Subsidy (incl Bonds): Rs. 64,866 Crores ($13.32 Billion)
  • Food Subsidy: Rs. 11471 Crores ($2.36 Billion)
  • NREGA: Rs. 25,000 Crores ($5.13 Billion)
  • Farmer’s Debt Relief: Rs. 15,000 Crores($3.08 Billion)
  • Transfer to States: Rs. 12,741 Crores ($2.61 Billion)

The total cost of those subsidies (including bonds) and other packages is Rs. 223,525 Crores ($45.9 Billion) which means, the it works out to 4.4% of the India’s GDP. If the Govt adds the reduction in tax collections, it could cost 1 per cent of GDP. According to the Economic Advisory Council (EAC), the Fiscal Deficit in the Union Budget had been placed at 2.5% to which, the addition of 4.4% and 1% to this number would definitely raise the total to nearly 8% of the GDP. Credit Rating agencies like Standard & Poor’s (S&P), Moody’s and Fitch are closely watching the India’s fiscal shortfall and this would definitely force them to downgrade the India’s Sovereign Debt rating. On Tue, Feb 24, 2009 S&P has reaffirmed the India’s rating to BBB-, means downgrading India from “Stable” to “Negative” outlook. 

What would happen, if the Fiscal Deficit rises? It means, that the Government will borrow extra to finance their expenditures (planned or non-planned). We won’t evade the higher monetary inflation. If the Government borrows extra for its spending, then the level of money supply will rise because it will force the Reserve Bank of India (RBI) to print more money – which would lead to the higher inflation at least in the medium term. Currently, the India’s national debt is 59% of the annual gross domestic product (Central and State Government combined). At VMW, we have earlier discussed about the deflation in the Developed Economy, however we’ve ruled out the Headline Deflation in India. Maybe the short term, Government borrowing will prevent the further fall in inflation. There is also a possibility of higher interest rates in the long run. 

As a result, there is a limited room for the Government to ramp up the spending without causing the structural harm to the economy. That’s why the Government is reluctant to cut tax rates and in the near future, Government may also consider reducing subsidy burden on Oil and Fertiliser by 1.6% of the GDP and this Interim Budget proves merely a performance review of the Government. 

Please Note: All figures in US Dollar (USD) terms are converted at Indian Rupee (INR) 48.70 aganist the USD. 

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