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What Dr. Reddy worries about? - Views on News from Equitymaster
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  • Oct 5, 2007

    What Dr. Reddy worries about?

    The role of being the chief of the Central Bank of one of the biggest economies in the world, particularly in times as these, is certainly not an enviable one! After his counterparts in the Western world have taken the so-called 'bold steps' of lowering the short term interest rates in a bid to save their respective economies from getting into a recession cycle, all eyes in this part of the world are now fixed on the RBI governor Dr. Y.V. Reddy. Known to pay little heed to the trend in West let alone aping them, Dr Reddy is, as in the past, expected to take an independent course. We herein contemplate some of the key concerns that he will mull over before the upcoming half-yearly review of the monetary policy.

    Inflation: The headline inflation benchmark (WPI) see-sawed from a low of 3.7% in April 2006 to 6.7% in January 2007 to 5.9% in March 2007. Both demand and supply side factors added to inflationary pressures during FY07. Demand pressures emanated from high investment and consumption demand, strong growth in credit and monetary aggregates and elevated asset prices. Supply side pressures emerged from demand-supply gaps in domestic production of major food grains amidst rising global crude oil prices. Although there was some improvement in domestic agricultural production during FY07, the production of major food grains has exhibited stagnation over the past few years. Going forward, interest rates, both short and long-term are expected to remain stable with the strong pick up in deposit mobilisation and abundant liquidity in the system. However, this does not dilute the inflation concerns. Despite the recent inflation numbers seeming to hover within the RBI's comfort levels, in the event of the current harvest season not proving to be bountiful, it is unlikely that the inflationary tendencies will be kept at abeyance.

    Balanced credit growth: While the slowdown in incremental credit growth from 30% YoY to 23% YoY was well anticipated, the same does not go well with the RBI's GDP growth targets. Infact, bankers now estimate the slowdown to go as low as 20% YoY this fiscal. While the recent rate hikes and liquidity tightening measures by the RBI (CRR hikes) did a good job of checking the liquidity flow to the risk weighed real estate, construction and mortgage sectors, it is feared that it may also hamper lending to the corporate sector. This is because banks are likely to give a preferential treatment to the high yielding retail assets to save their margins.

    Exports: India's linkages with the global economy have been getting stronger, underpinned by the growing openness of the economy and the two-way movement in financial flows. The ratio of merchandise exports to GDP has been rising since the early 1990s reflecting growing international competitiveness. Having said that, the merchandise exports have been a cause of worry in recent times. In July 2007, the growth in merchandise exports of 18.7% was a sharp deceleration from the 40.8% rise recorded a year ago. In rupee terms, the slowdown was more striking with realisation from exports rising by a mere 3% in July 2007 against a hefty 50% recorded in July 2006, thanks to a swift 15% appreciation in the Rupee against the Dollar.

    Credit rating: The leading rating agencies across the globe - Moody's, Standard & Poor's and Fitch - are under scanner these days for fueling the subprime mortgage meltdown with excessively high ratings on mortgage-backed bonds that turned out to be bad bets. The problem emanates from the fact that the rating agencies are rife with conflicts of interest. They are paid by the issuers to evaluate the risks of their debt offerings. Although the Indian rating agencies have been saved from the blushes so far, thanks to the regulators' (Reserve Bank of India (RBI), NHB, Securities and Exchange Board of India (SEBI)) strict governance, the Central Bank cannot help but keep a close watch on such proceedings.

    Thus the RBI has to juggle between several probables and maneuver a policy that can keep a strict vigilance on the weakest economic linkages that have the potential to launch the growth engine on to a tailspin.



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