Saturday 17 April 2010

RBI MONETARY POLICY April 2010-What are the expectations?-VRK100-17042010

RBI MONETARY POLICY APRIL 2010


WHAT ARE THE EXPECTATIONS?


Rama Krishna Vadlamudi, BOMBAY          April 17, 2010


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"Lender of the Last Resort"

This is the most apt phrase that has been used in the past to describe a central bank in any country. However, central banks do not only this but also several functions, like, monetary policy, price stability, stimulating the growth drivers in the economy, currency note printing and acting as money manager for the governments, among other things. Due to several upheavals in the financial world, the role of central banks has transformed a lot lately.



"Market Maker of the Last Resort"

This is a new phrase ascribed to central banks during the global financial meltdown of 2008. During that time, almost all the central banks, including the US Fed, ECB, PBOC, etc, had pumped in huge money into their country’s banking system in an effort to avoid economic recession. This massive effort was dubbed as ‘quantitative easing.’ As a result of buying back of mortgage securities of inferior quality and other securities, the central banks have avoided the collapse of their banking system for the time being. Even Reserve Bank of India massively reduced its policy rates and reserve ratios and helped stabilizing the Indian markets.


"Borrower of the First Resort"


Reserve Bank of India had continued with its accommodative policy till the end of January 2010 when it raised the country’s cash reserve ratio (CRR) by 75 bp to 5.75 per cent. It was followed up with a 25 basis point hike each in both repo and reverse repo rates at the end of last month. But despite that, During the first week of April, banks kept around Rs 1,00,000 crore daily with the RBI and this has now come down to a daily average of about Rs 50,000 crore – which means RBI is borrowing money from banks for short-term and it has become a Borrower of First Resort – and what a transition from lender of last resort to borrower of first resort!


Reserve Bank of India is coming out with its Annual Policy (monetary policy) for the year 2010-11 on April 20, 2010. Only three weeks back, RBI had given a strong signal regarding its strong intentions to control inflationary expectations by raising the repo and reverse repo rates by 25 basis points each to 5 and 3.50 per cent respectively. In the month of January, it raised CRR (cash reserve ratio) by 75 basis points to 5.75 per cent. In this background, it is very interesting to predict what actions RBI will take to keep the economy on even keel balancing between containing inflation and sustaining reasonable growth. Let us discuss the expectations from the RBI’s monetary policy for 2010-11.



Till January, RBI continued with its accommodative policy for around 18 months in the wake of financial turmoil that roiled the markets severely. Despite steep hike in CRR and withdrawal of other measures, there is still huge liquidity in the banking system.



Reserve Bank of Australia raised its benchmark interest rate by 25 basis points to 4.25 per cent in a meeting early this month. The US had raised its discount rate by 25 basis points to 0.75 per cent in February this year for the first time in more than a year. China is also raising its cash requirement ratios regularly since January 2010.



For the month of January of this year, inflation based on wholesale price index (WPI) was 8.56 per cent. But, in two months it has gone up to almost 10 per cent. This indeed is a very sharp increase in inflation. Even, food inflation is still around 17 per cent. How the South-West Monsoon will play out remains to be seen. Fuel prices were raised at end February. Whether fuel prices will be raised further by the Government, as world crude oil prices had shot up to USD 87/barrel on the Nymex, has become a big speculative point in the markets of late. Even though crude prices have come down to less that USD 83 per barrel, the sharp rise in crude prices is a matter of concern to the Government in bridging fiscal deficit in the current year.

FOREIGN FLOWS:

As can be seen from the above table, there is a deluge of foreign money into India since March 2009. In addition to equity markets (both secondary and primary markets), debt markets too attracted net inflows of USD 4,785 million or Rs 21,887 crore during this calendar year alone, breaching the overall limit set by the Government for FII debt flows. Rupee too appreciated sharply of late. This year it had shown an appreciation of around four per cent against the US dollar. Now, rupee was quoting at around 44.30 to the dollar at close of Friday.



The above FII figures do not include money received through FDI (foreign direct investment) route or ECB/FCCBs (external commercial borrowings/foreign currency convertible bonds). Latest figures from RBI put foreign exchange reserves at Rs 12.43 lakh crore or USD 280 billion. During 2009-10, the reserves went up by 9.4 per cent in dollar terms, but in rupee terms the appreciation in reserves was less than two per cent as rupee itself appreciated against dollar by around 12 per cent in 2009-10. The table given below shows the FII net inflows for calendar year 2009. Both equity and debt markets including, India attracted net inflows of USD 18,507 million or Rs 87,987 crore, as per SEBI.


What are the expectations from RBI’s Annual Policy on April 20, 2010?



It is estimated by government agencies that India’s GDP would show a growth of 7.2 per cent for 209-10. During the third and second quarters of 2009-10, GDP grew by 6.0 and 7.9 per cent respectively. For the fourth quarter of 2009-10, GDP is expected to grow by 8.6 per cent. Industrial production seems to have gained traction of late as per the IIP figures, prompting the government to raise excise/CENVAT duties during February. Exports are showing moderate growth compared to previous year.



The yields of the government securities are hardening. As per latest data, the benchmark 10-year G-Sec yield has gone up, in the last three months, by around 40 basis points to the present 8.08 per cent; while the 364-day T-bill has increased by 100 basis points to 5.40 per cent.



The government is expected to borrow 63 per cent of its total borrowing during the first half of this year. This year will be tough for RBI to manage the huge government borrowing as it did not have the cushion it had last year in the form of MSS buyback of securities. The year 2010-11 is going to be a real test for RBI. Interest rates are on an upward trajectory as inflation is not showing any signs of relenting with WPI inflation at 9.9 per cent and food inflation at around 17 per cent. Steel and other manufacturing product prices too are rising. RBI may resort to some unconventional measures this year, like, issue of more floating rate bonds, tweaking of HTM category norms, cash management bills, or a cap on LAF-reverse repo window, or some other measures. During YV Reddy’s regime, RBI imposed a limit on reverse repo absorption window, which was withdrawn subsequently. Another measure at RBI’s disposal is hiking SLR ratio.



Huge inflows in the form of portfolio investment, ECB/FCCBs and FDI are going to be a big challenge. Whether the government would resort to taxing the FII/FDI inflows (like Tobin Tax or a transaction tax imposed by Brazil recently) remains to be seen. The imposition of a tax similar to Tobin Tax to curb unbridled growth of foreign money is strongly advocated by YV Reddy, former governor of RBI.



Taking the rising inflation, huge liquidity in the system, deluge of foreign money, robust GDP growth, the following policy measures can be expected from RBI:



 Raise in repo and reverse repo (LAF) rates by 25 basis points each



 Raise in CRR by 50 basis points



In the bond market, the benchmark 10-year yield may go up to 8.50 per cent gradually; while the stock market may react negatively and the indices, especially, banking, auto & realty indices, may drift down in the next one month.



Design and tables: Author                              Disclaimer: The views are personal

Chinese Yuan Revaluation-China and America are at loggerheads-VRK100-16042010

IS IT THE ULTIMATE CURRENCY WAR?


AMERICA AND CHINA ARE AT LOGGERHEADS


WHAT IS THE STORY BEHIND THE STORY?

Rama Krishna Vadlamudi                             April 16, 2010

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The controversy surrounding the revaluation of Chinese currency Yuan has occupied the attention of the market players and politicians in the last few months. The million-dollar question is: will they or won't they – meaning whether China will allow its currency to appreciate against the US dollar?

Two weeks back, American Treasury Secretary Tim Geithner postponed releasing a Currency Report. It was expected that this report would have dubbed China as a ‘currency manipulator’ – triggering a trade war between China and America. Such a trade war would have adverse implications for the world trade and would send shock waves across the global financial markets. So, what are the chances of such a panic reaction from the markets happening in the next few quarters? Let us try to examine the issue in detail:

THE SPAT BETWEEN PAUL KRUGMAN AND STEPHEN ROACH

China has kept the Yuan stable against the dollar since September 2008, when Lehman Brothers collapse caused havoc in the financial markets across the globe. Many Americans, including Nobel laureate in economics Paul Krugman, believe that America should pressurize China to appreciate the Yuan. Those in this ‘hard line’ camp argue that China is causing a lot of damage to the world trade (read it as American economy) by keeping the Yuan pegged to the dollar constantly. A few months back, a Reuters’ Survey had put the undervaluation of Yuan at around 20 per cent, meaning Yuan should have moved from the present 6.83 to around 5.50 per dollar had China not halted its appreciation in September 2008 post-Lehman Brothers collapse.

However, there are others who believe that America alone is responsible for its twin deficits - both trade and fiscal. A respected financial expert Stephen Roach, Morgan Stanley Asia chairman, argues that America should mind its own business rather than blaming China for the woes of their own-making. He openly crossed swords with Paul Krugman recently about the American strategy on Yuan revaluation. A big problem for America is its lack of competitiveness.

If Yuan appreciates against the dollar, it will make Chinese exports to America costlier. And this may help bridge the big trade deficit America has with China in a limited way. America has got its own problems. For example, it has got huge fiscal and trade deficits. And Chinese exchange rate policy is not responsible for American mess which is self-created. Another thing is America is not a nation of savers, like, Japan or Germany. Till recently, Americans had negative savings. After the global financial meltdown, there is some upturn in savings from American households.

CHINA IS WORLD’s FACTORY:

China is a global manufacturing factory and is heavily dependent on its exports. Any adverse impact on its exports will undermine its labour markets. China has to protect its domestic economy from the ill-effects of the global financial meltdown. China’s first priority is to protect the jobs of its domestic workers, in an effort to “maximize export employment.” So, it has been playing very hard with its currency by not allowing any appreciation against the US dollar. However, this has earned the wrath of many of its trading partners.

China has been enjoying huge trade surpluses (exports much higher than imports) for several years. As a result of its long-running trade surplus, China amassed huge foreign exchange reserves, which are at USD 2.45 trillion as at the end of March 2010 making China the world’s biggest holder of foreign exchange reserves. In Indian rupee terms, China’s reserves are at Rs 109 lakh crore or almost nine times that of India’s reserves. India’s latest figures show their foreign exchange reserves at Rs 12.4 lakh crore or USD 280 billion. (1 trillion = 1,000 billion or one lakh crore)

Paradoxically, out of this massive foreign exchange reserves of USD 2.45 trillion, China has invested around USD 900 billion in US Government securities (or US Treasurys). It is in the interest of both America and China not to escalate the current controversy into a full-blown trade war. A trade war does not do any good to either country. So, in the interest of world trade, these two countries shall desist from any hawkish approach and try to look for some ‘soft’ approach in resolving the current currency row.

CHINA EASED ITS CURRENCY POLICY IN JULY 2005



China eased its currency policy in July 2005. At that time, their central bank, the People’s Bank of China, made it clear that it would ‘ease’ but not abandon its traditional peg to the dollar. It had allowed a managed float for Yuan against a basket of currencies of countries with which it trades. In July 2005, one US dollar was fetching around 8.30 Yuan. With its managed float stance, the Yuan is quoting at around 6.83 to the dollar now – indicating an 18 per cent appreciation of Yuan against the dollar between July 2005 and September 2008.



Since the middle of September 2008, China reverted back to its traditional peg to the US dollar. Many other Asian countries, including India, have allowed two-way movement of their national currencies against the US dollar despite their own economic problems.



JOSEPH STIGLITZ: No time for trade war

“Saudi Arabia’s trade surplus of USD 212 billion (11.5% of its GDP) in 2008 dwarfs China’s USD 175 billion surplus (5% of its GDP), as a percentage of GDP. China’s current account surplus is actually less than that of Japan and Germany (5.2% of GDP). Then, why blame China alone for American deficits?”

Thus said Joseph Stiglitz, Nobel Prize winner of economics, in an article published in Economic Times dated April 16, 2010



CHINA AND AMERICA: SIAMESE TWINS?



The dollar has appreciated by about 10 per cent against major currencies in the last five months easing the Chinese concerns on the safety of their investments in US Treasurys. On its part, China needs to reorient and rebalance its economy from export-driven to domestic consumption-led, like the way India has been doing now. All indications at this point of time show that in the next year China would definitely allow Yuan’s appreciation of around 4 to 6 per cent with a caveat that they would do it at their own pace and convenience.



If America and China decide to go for a full-blown trade war, this would have disastrous consequences for world trade – which would send the stock markets into a jittery phase and the indices may fall sharply in a matter of few days if not hours.


Picture courtesy: PBOC, US Treasury

Tuesday 13 April 2010

IPL FINAL MATCH! Fierce Fighting between Mumbai and Hyderabad-VRK100-12042010

IPL FINAL MATCH!


Fierce Fighting By Mumbai and Hyderabad!






Rama Krishna Vadlamudi, BOMBAY      April 12, 2010

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A different kind of battle is being fought fiercely by the plucky Mumbai and the resilient Hyderabad teams. The brawl is about who should control the Indian ‘Premium’ League (IPL). Sorry guys! This is not about IPL – the Indian Premier League. The slugfest is about the battle for ‘Premium’ that investors pay for their investment in Unit Linked Insurance Plans being sold by life insurance companies. Well, the Mumbai-based SEBI and the Hyderabad-based IRDA are fighting an unprecedented turf war in Indian financial markets. This is about who should control ULIPs. ULIPs are basically savings products with a sprinkle of insurance. While about 95 per cent of the ULIP premium will be invested in equity markets, the remaining five per cent is set aside towards the life cover of the insured, that is the ULIP policyholder.


FLASH NEWS!



Meanwhile, latest news being flashed by the media is that the crisis about ULIPs has been resolved temporarily after the intervention of the Government through the Finance Minister, Pranab Mukherjee. The Ministry of Finance has devised a formula for resolving the tussle. As per the formula, SEBI and IRDA have agreed to decide the issue in an appropriate court, whose judgment would be binding on SEBI and IRDA.



The last word is yet to be said about the controversy. We can expect lot of fireworks in the next few quarters if not years in this regard.



What is the background to the row?



The latest row had started when SEBI had banned 14 life insurance companies from selling ULIPs a few days back. A day later, IRDA had directed insurance companies to ignore SEBI’s order and continue to sell ULIPs as usual. This had created a lot of confusion among millions of ULIP policyholders.



SEBI argues that ULIPs come under the purview of Collective Investment Schemes – this financial product is regulated by SEBI. SEBI’s contention has been that insurance companies should take its permission before launching any ULIPs. As the structure of ULIP is basically investment in equity markets, SEBI’s seems to be correct in its stance of regulating ULIPs. SEBI’s is on a good legal wicket as far as regulation of ULIPs is concerned.



As we have seen in the case of Exchange-traded Currency Futures (which were introduced in August 2008), two entities can regulate any financial product if there is an overlap. Both SEBI and RBI regulate currency futures market in India . Even in case of Exchange-traded Interest Rate Futures (which were introduced in August 2009), both SEBI and RBI are the regulators. As such, it would not be wrong to think that ULIPs can be regulated by both SEBI and IRDA.



Are our laws inadequate?



Ajay Shah, a veteran expert on financial markets from NIPFP, argues that more products may need to be brought under joint regulation. He argues that Government Securities, which are traded on NDS platform daily, shall be brought under the control SEBI.



We have one body called High-Level Coordination Committee on Financial Markets (HLCCFM) with representatives from several regulators, RBI, SEBI, IRDA, etc. This body is headed by RBI. This is supposed to resolve inter-regulatory issues.



New Initiatives by GOI



One initiative in the recent Union Budget 2010-11 is the proposal to set up a Fiscal Stability and Development Council to sort out any issues between the regulators of financial markets, like, RBI, IRDA, SEBI, PFRDA, etc. Let us hope that initiatives like these will bring more clarity on India ’s financial sector regulation in future.



Another important area that has been hanging fire for a long time is who should control financial conglomerates – which operate in all areas of finance from insurance, banking to mutual funds. RBI has been sitting on the framework for establishing holding companies for Banking Group.



The country’s biggest bank, SBI and ICICI Bank wanted to set up their own holding companies encompassing all its businesses, from banking, insurance and mutual funds. ICICI Bank wanted to monetize its insurance and AMC businesses. But, RBI and the




WHAT SHOULD INVESTORS DO?



Even though IRDA has taken a number of initiatives to curb the practice of mis-selling them, ULIPs are not suitable to many investors – simply put, they are bad products for most of the investors. In India , most of the individual investors are risk-averse; but, they have been sold these ULIPs..



Investors need not worry about the controversy between SEBI and IRDA. Things will take their own course in India . If investors understand the ULIP products well, they can continue to invest their money in ULIPs after assessing their asset allocation, risk appetite and suitability of the financial products. My personal opinion is that ULIPs are bad products despite some improvements in their structure in the last few quarters. It would be better if we avoid them at all costs.


Disclaimer: The views of the author are personal.               Picture courtesy: Google



You can read some of my BEST documents at…


1. IFRS-A Guidebook on Convergence to Global Standards – VRK100 – 28032010

http://www.scribd.com/doc/29050580


2. RBI hikes Repo and Reverse Repo Rates by 25 bp – WHY? – VRK100 – 20032010

http://www.scribd.com/doc/28660075

3. Income Tax Slabs 2010-11-Resident Indians, Salaried Class, HUF, Etc-VRK100-28022010


http://www.scribd.com/doc/27601595

4. Indian Budget 2010-11 - HIGHLIGHTS and ITS impact on Individuals and Companies-28022010


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5. GREECE DEBT CRISIS - A Greek Tragedy Amid Double-Dip Recession Fears-VRK100-16022010

http://www.scribd.com/doc/26955409


For more, www.scribd.com/vrk100


The author writes copiously, blogs extensively and invests in stocks for fun!