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 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%.

(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

(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.

Banks Cutting Interest Rates in order to make Cheaper Home Loans.

However, banks are only announcing the rate cut on loan upto Rs. 2.0 million. ($42,000). No relief for the existing borrowers.  
A Construction site in New Delhi.

A Construction site in New Delhi.

Subsequent to the recent RBI’s rate cut announcement, the banks are responding and cutting down the interest rates on home loans by 50 bps to 100 bps.The interest rates are vary from bank to bank. If the borrower seeking for the home loan of Rs 2,000,000.00 (Rs. 2 million) or below, then the banks are offering loan at the rate between 9.5% and 13% on floating rate and fixed rate respectively. However, the above rates are only applicable on new home loan application for the loan of upto Rs. 2 million. (Rs. 20 lacs).

Since the property prices in Tier 1 cities are not available in the range of Rs. 2 million or so, the rate cut announcement by the banks are inappropriate and specially for the existing borrowers. Banks are only giving lower interest rates on cheap home loan and only to the new customers. The existing customers are still unhappy and didn’t get any benefit from the RBI’s Repo rate cut and Reverse repo cut. That’s why, the developers are morose too with the Indian banking Association’s (IBA) move. Many developers are against with the banks’ decision to not allowing the cheaper loan on more than Rs. 2 million.

The big question arises that, Why banks are averse to offer cheaper home loan across the board? When the interest rates went up in the last few months, then banks have raised the rates on all type of loans, whatever the loan size, it doesn’t matter. Now the RBI is cutting its benchmark interest rates, banks are not doing so. Why?

Many Banks have argued that the deposit rates are above the RBI’s benchmark interest rates and they cannot cut the borrowing cost unless the deposit rate soften. That is the reason the banks aren’t cutting down the interest rates. According to the PSU banks’ balance sheet, over 80% of home loan assets comprise the loan portfolio of Rs. 2,000,000.00. In order to cut Prime Lending Rate (PLR, the rate at which banks lend to their best customer), the banks need to cut down their deposit rates, so that the lower cost of credit will available to everyone. RBI had cut the Cash Reserve Requirement (CRR) by 350 bps in the last 3 months to improve the liquidity in the system however, the banks’ main source of liquidity is from the deposit from the customers and they cannot cut deposit rate as they don’t have enough liquidity. Main sectors are also suffering from the higher interest rates. In addition to the real estate sector, SMEs are also facing the burden of higher interest rates. Recently the World Bank have agreed to lend upto $14 billion (Rs. 67,000 Crores) in the next three years, which would help to recapitalize the state run banks. As the liquidity dried up, the banks are unable to access long term financing in order to focus on Real Estate, Small and Medium Scale Entreprises (SMEs) and infrastructure.