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RBI rate hike: Speaking the world language! - Views on News from Equitymaster
 
 
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  • Jun 9, 2006

    RBI rate hike: Speaking the world language!

    I. Statement from the Central Bank of the Republic of Turkey while raising short term lending rates from 16.25% to 18.0% (June 7 2006)
    "According to the April and May inflation figures, the annual inflation rate significantly exceeded the target path. Moreover, annual inflation figures to be recorded in the next months might further go up temporarily, with the pass-through effect of the exchange rate movements arising from the recent volatility in financial markets. The Monetary Policy Committee has deemed it necessary to revise the policy rates in order not to let such temporary developments cause permanent effects on the medium-term expectations and pricing behaviors, and also to make sure that the medium-term inflation trend is kept in line with the targets."

    II. Statement from the Monetary Policy Committee of the Bank of Thailand (June 8 2006)
    "With the oil prices surging more than expected and causing inflation to clearly accelerate beyond the committee's previous projections, there continued to be a need to maintain the tightening policy stance at this time. Therefore, the committee decided to raise the 14-day repurchase rate by 25 basis points from 4.75% to 5.0%, effective immediately.

    III. Statement from the Bank of Korea while raising short term lending rates from 4.0% to 4.25% (June 8 2006)
    "There are arising inflationary pressures due to the economic recovery and persistently high oil prices. The recent rebound in real estate prices has continued. In the financial markets, overall liquidity conditions are favorable and financial institutions' loans have shown a sharp increase."

    IV. Statement from the Reserve Bank India (June 8 2006)
    "On a review of current macroeconomic and overall monetary conditions, the Reserve Bank of India (RBI) has decided to increase the reverse repo rate by 25 basis points to 5.75% from 5.5% with immediate effect. Simultaneously, the repo rate, which continues to be linked to the reverse repo rate with a spread of 100 basis points, is also being increased by 25 basis points to 6.75% from 6.5% with immediate effect."

    Spot the difference in the abovementioned policy statements from central banks of the four 'emerging economies'! We bet you will not find many except the difference in languages used to convey the central theme - EASY MONEY IS NO MORE EASY! Tightening liquidity and rising inflation led by higher crude prices has been the basis of this theme for central bankers worldwide.

    In wake of rising pressure on central banks to tide in inflationary pressure, worries of higher interest rates have fueled a drop in stock markets around the world in the past few weeks. The fear is that if interest rates go too high, it could consequently lead to deceleration of the global growth engine, or even lead to a worldwide recession. The immediacy with which the emerging market central banks have hiked the lending rates has also been seen in the corresponding equity indices. India was down 4.7% (though before the hike was announced) and Korea and Thailand were weak by 3.5% and 2% respectively after rate hike announcements. Turkey closed with 2% losses on June 7.

    So, does the RBI's latest rate hike sound panic bells? Not really, for long-term investors! This decision by the RBI reflects the upside risks to price stability (inflation) over the medium term. Thus, the consequent hike in interest rates will contribute to ensuring that long-term inflation expectations remain anchored at levels consistent with price stability. Investors need to appreciate the fact that such an anchoring is a prerequisite for monetary policy to make an ongoing contribution towards supporting economic growth.

    In the interim, however, even long-term investors need to be cautious with respect to India Inc.'s growth expectations, considering that profitability is likely to come under pressure on the back of higher interest costs on debt taken for expansion purposes.

    Overall, at the current levels, Indian equity markets are trading at a price to earnings multiple of 15.3 times trailing twelve months earnings. Factoring a 12% compounded growth in net profit during FY06 to FY08, the valuations are 12.2 times, which we believe are attractive. The decline in the past couple of weeks should not be considered a loss but taken as an opportunity to build up a sound long-term equity portfolio.

     

     

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