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Monetary Policy: Fears are now real

Apr 29, 2008

Having won accolades from the world over for being one of the most 'independent' central banks, the RBI (Reserve Bank of India) has once again displayed its independence in the annual Monetary Policy for fiscal 2008-2009. The same has not only brought the concerns with regard to liquidity conditions, growth rates and credit risks to the fore but may also force the speculators who tried to be indifferent to the problems, bite the dust. In its trademark manner, the RBI has once again used its oft-resorted tool, the CRR (cash reserve ratio), to tighten the reins of money supply in to the economy. As per this mandate, banks will now have to maintain 8.25% of the net demand and time liabilities (essentially savings, current and fixed deposits) as CRR (effective 24 May, 2008). This means that of every Rs 100 that the banks have in the form of deposits, they will be left with only Rs 66.75 (Rs 100 less CRR Rs 8.25 less SLR Rs 25) for lending purposes. Whether the same will put pressure on interest rates? This is yet to be figured out given the fact that the demand for loans (both retail and corporate) has already shown some signs of cooling off in FY08.

For FY09, the central bank has projected the GDP growth rate in the range of 8.0% to 8.5% (8.7% in FY08) with the money supply expansion moderated in the range of 16.5% to 17.0% (21% in FY08). This is notwithstanding the fact that the central bank will be targeting to bring down inflation to around 5.5% in FY09 with a preference for bringing it close to 5.0%. The bank also estimates the economic slowdown to have an impact on deposit accretion and loan offtakes in the books of banks with the two growing at 17% YoY and 20% YoY respectively in FY09 (both grew 22% YoY in FY08).

Two other notable facts highlighted by the RBI in this policy are that the limit of mortgage loans to individuals having lower risk weight of 50% has been enhanced from Rs 2 m to Rs 3 m and that all transactions of Rs 100 m and above will be mandatory to be routed through the electronic payment mechanism. While the former will ease the interest cost on lower ticket home loans, the latter is expected to bring in more transparency in transaction of large volumes.

We reckon that for investors in equities, the RBI message signals only one thing. That while there is no reason to panic or change exposures or pay heed to the market noise, investors certainly need to temper down their expectations of returns beyond 15% per annum, especially in case of the large cap stocks. This is particularly taking heed of the fact we are starting this fiscal on a very high base (across parameters) and the near term outlook is relatively muted. This is however, notwithstanding the fact that the long term growth story stands intact!

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