The Whys And Wherefores Of RBI's Aggression

KEY POINTS

• The reason for the RBI’s aggressiveness in its monetary policy could be the data revision for the month of January 2012, wherein the IIP was brought down from the earlier reported 6.8 per cent to 1.1 per cent, suggesting that the domestic economy is slowing down and needs a major boost.
• The move is a positive one for interest rate-sensitive sectors like Real Estate, Banking and Auto.
• The interest rates may not come down substantially for end customers, as the liquidity situation continues to remain tight with the governments’ huge borrowings programme. Banks may pass on at the most 20-40 basis points of the overall cut to the end customers.

After a prolonged wait, the interest rate cycle has finally taken a U-turn. This has ushered in hopes that the economy will see some good growth going forward. While there was a widespread consensus on a 25 basis point cut in the rates, the RBI Governor has bettered the expectations. In what was a major move, the RBI has slashed the repo rate by 50 basis points to eight per cent, while the reverse repo rate has been further adjusted by 100 basis points to seven per cent. The central banker, however, left the cash reserve ratio (CRR) unchanged at 4.75 per cent. It has also raised the borrowing limit of the Scheduled Commercial Banks (SCBs) under the marginal standing facility from one per cent to two per cent of their net demand and time liabilities (NDTL), which would further ease the liquidity pressure on banks.

So, why did the RBI get so aggressive in its monetary policy? Well, the reason for this aggressiveness could be the data revision for the month of January 2012, wherein the IIP was brought down from the earlier reported 6.8 per cent to 1.1 per cent, suggesting that the domestic economy is slowing down and needs a major boost. The RBI has probably seen through the ineffectiveness of rate hikes in taming inflation over the past, and hence, has decided to give ‘growth’ a chance. However, we at DSIJ, strongly believe that this could be the only rate cut for 2012. Inflation is bound to remain above the comfort zone of the RBI, and this will force the regulatory authority to take measures to control it.

On the other hand, we do not expect the rates of interest to come down substantially for end customers due to this policy, as the liquidity situation continues to remain tight with the governments’ huge borrowings programme. The best-case scenario is that banks may pass on at the most 20-40 basis points of the overall cut to the end customers.

Since the RBI’s move is effective immediately, one may see some tinkering by banks within the next couple of days. Hence, investors who have funds or cash and who wish to invest in fixed deposits with banks should rush to do so, as the same deposit for the same tenure might very soon be available at approximately 25 basis points lesser than the current one. On the other hand, those who wish to avail themselves of loans from banks might just be benefited by waiting it out for a couple of weeks or negotiating with the bankers.

We are of the opinion that the RBI should have continued with its pause with respect to interest rates or at the most, should have cut the repo rate by 25 basis points. Inflationary pressures will continue to hover on the economy in the near-to-medium term. For the betterment of our economy, we hope that things work as per the RBI’s projections and that inflation continues to moderate going ahead and growth picks up slowly and steadily.

We are not sure what the RBI will do if inflation goes up going ahead. Nevertheless, the move is definitely positive for interest rate-sensitive sectors like Banking, Real Estate and Auto.

As of now, the RBI has acted on its part. It is time that the government acts as well and ensures that the economy gets back on the growth path.

Highlights Of The RBI’s Monetary Policy Statement

• Domestically, the state of the economy is a matter of growing concern.
• Global macro-economic conditions have shown signs of a modest improvement.
• The growth in IIP has been at 3.5 per cent for April-February in FY 2012 against 8.1 per cent in the previous year.
• The RBI’s Industrial Outlook Survey showed a pick up in the business sentiment in Q4FY12, but a marginal moderation in Q1FY13.
• The pricing power of Indian companies is diminishing, and hence, they are finding it difficult to pass on the rising input costs to their customers.
• The 10-year benchmark yield stands at 8.6 per cent as on April 13, 2012 as compared to eight per cent as at the end of March 2011.
• The industry is expected to perform better than they fared in the last year, as leading indicators suggest a turnaround in IIP growth.
• The domestic growth outlook for FY 2012-13 looks a little better than that in FY 2011-12.
• The GDP is projected to grow at 7.3 per cent in the current year.
• There isn’t too much scope for monetary policy easing without aggravating inflation risk.
• Crude oil prices are expected to remain high.
• The baseline projection for WPI inflation for March 2013 is placed at 6.5 per cent.
• Inflation is expected to remain range-bound during the year.
• M3 growth is projected at 15 per cent for the current year.
• The aggregate deposits of SCBs are projected to grow at 16 per cent.
• The growth in non-food credit of SCBs is projected to be at around 17 per cent.
• Even though the Union Budget envisages a reduction in the fiscal deficit in FY2013, several upside risks to the budgeted fiscal deficit remain. Particularly, the containment of non-plan expenditure within the budget estimates for 2012-13 is contingent upon the government’s ability to adhere to its commitment of capping subsidies.
• Based on the current assessment, the economy is clearly operating below its post-crisis trend.
• There RBI has reduced the repo rate from 8.5 per cent to eight per cent.
• CRR has been maintained at same level.
• It is imperative for macro-economic stability that the administered prices of petroleum products are increased to reflect their true costs of production.