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
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