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Reddy - Steady - No! - Views on News from Equitymaster
 
 
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  • Jan 29, 2008

    Reddy - Steady - No!

    ...says Dr. Yaga Venugopal Reddy, the RBI Governor to demands for interest rate cut in India following similar measures taken by his counterpart in the US. Defying the 'ardent' requests for interest rate cuts for Indian corporates and consumers, the RBI, in his third quarter review of the monetary policy for 2007-08 has maintained the benchmark interest rates at the current levels. The RBI has kept -

    • Bank Rate unchanged at 6%;

    • The reverse repo rate and the repo rate unchanged at 6% and 7.75% respectively; and

    • Cash reserve ratio (CRR) unchanged at 7.5%.

    And the Indian stock market have tanked! Why? Because the chieftains of India Inc. and stock market experts were all expecting the RBI Governor to toe the line of Ben Bernanke (US Federal reserve Chairman) in cutting interest rates, which he has not done. While the Fed had recently 'slashed' its benchmark short-term rates by 0.75% (to 3.5%) as a way to ease the credit crunch and lead the US economy out of a 'very much' possible recession, the demands for rate cut in India was based on a different case.

    It was argued that since the US interest rates are moving down, the spread between the same (US rates) and Indian rates is on a rise. This has the possibility of leading more foreign inflows into the relatively attractive Indian assets (stocks and bonds), thus leading to a further appreciation of the rupee. We believe that this was not a really compelling argument for the RBI to cut rates.

    This is because the Indian economy continues to chug on a strong growth path (RBI expects GDP growth in FY08 to be 8.5%). Also, while the headline inflation numbers seem appeasing, readers should note that the impact of high global crude prices and rising food prices is not really seen in the same. The RBI has, in fact, reiterated its stance of maintaining inflation close to 5% in FY08 and then 3% in the medium term. In maintaining the interest rates, the RBI has also noted that while there has been a deceleration in non-food credit, money supply continues to expand at rate that is higher than the central bank's projections.

    The central bank has also raised concerns about the slowdown in global economic growth. It believes that inflationary pressures have re-emerged as the key risk to global growth, citing examples like the US, UK, Euro-zone, and emerging markets like China, Malaysia, Indonesia and Chile. It has especially mentioned the persistence of high food, oil and other commodity prices as significant inflation risks for the global economy and challenges for monetary policy worldwide. Heightened uncertainties and emerging challenges posed by the US subprime mortgage crisis has also found way into the RBI's current monetary policy review.

    Overall, we believe that the RBI's latest stance of maintaining interest rates is very positive from a central bank independence perspective. We have been hearing many explanations from the Finance Ministry and other government officials as to what stance the RBI should follow. By not giving in to these politically driven requests (remember we are nearing elections) as also the ones from corporate head-honchos, Dr. Reddy has made a mark. Foreign investors might well see this as part of the increasing strength of the Indian banking and financial system, which might ultimately be beneficial for the Indian stock markets as well.

    Some of the key domestic and external developments that the RBI has talked about in the latest review are as follows.

    1. Domestic developments
      • Real GDP growth moderated to 9.1% in the first half of FY08 from 9.9% in the first half of FY07.

      • Inflation, based on wholesale price index (WPI) has eased to 3.8% as on January 12, 2008 from its peak of 6.4% at the beginning of the financial year (April 2007) and from 6.2% in January 2007.

      • Prices of primary articles have registered a 3.9% YoY increase as on January 12, 2008 as compared with 9.5% YoY a year ago.

      • Manufacturing inflation has eased to 3.9% as on January 12, 2008 from 5.8% a year ago.

      • The price of the Indian basket of international crude has registered a sustained increase during FY08, from US$ 66.4 (per barrel) in April-June 2007, US $ 72.7 in July-September 2007, US $ 85.7 in October-December 2007 to US $ 88.9 as on January 25, 2008.

      • Inflation based on the consumer price index (CPI) for industrial workers, urban non-manual employees, agricultural labourers and rural labourers was 5.5%, 5.1%, 5.9% and 5.6% in November 2007. These rates were 6.3%, 6.9%, 8.9% and 8.3% a year ago.

      • As on January 4, 2008 money supply (M3) increased by 22.4% YoY, which was higher than 20.8% YoY growth recorded a year ago and well above the projected trajectory of 17.0-17.5% indicated in the Annual Policy Statement for 2007-08.

      • Non-food credit of scheduled commercial banks expanded by 22.2% YoY as on January 4, 2008 against a growth of 31.9% YoY a year ago.

    2. External developments
      • During April-November 2007, India's merchandise exports rose by 21.9% in US dollar terms as compared with 26.2% in the corresponding period of the previous year. Import growth was also lower at 26.9% as compared with 27.4% in the previous year. The merchandise trade deficit widened to US$ 52.8 bn from US$ 38.5 bn in the previous year.

      • While oil imports recorded a lower growth of 9.8% during the April-November 2007 period as compared with 42% a year ago, non-oil imports increased by 35.3% as compared with 21.3% a year ago.

      • Foreign exchange reserves increased by US$ 85.7 bn during the current financial year so far and stood at nearly US $ 285 bn on January 18, 2008.

      • Over the end-March 2007 level, the rupee appreciated by 9.6% against the US dollar, by 8.9% against the UK Pound and by almost 1% against the Japanese Yen, but remained unchanged against the Euro as on January 25, 2008.

    Note: Key definitions

    • Repo - Agreement through which the RBI lends money to the banking system to tide over short-term liquidity crunch. The interest rate which the RBI charges banks for such lending is called the repo rate (currently at 7.75%).

    • Reverse repo - Reverse of repo. It is an agreement through which the RBI sucks out money from the banking system to tide over short-term excess liquidity situation. The interest rate that the RBI pays banks for such agreement is called the reverse repo rate (currently at 6%).

    • CRR (Cash Reserve Ratio) - CRR is the percentage of bank reserves to deposits and notes that commercial banks keep with the RBI. These reserves are designed to satisfy withdrawal demands, and would normally be in the form of currency stored in a bank vault, or with a central bank. CRR currently stands at 7.5% in India.

    • Bank rate - Bank rate, also referred to as the discount rate, is the rate of interest, which the RBI charges on the loans and advances that it extends to commercial banks and other financial intermediaries. Changes in the bank rate are often used by central banks to control the money supply. Bank rate currently stands at 6% in India.

     

     

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