So, the markets went into a tizzy after RBI Guv spoke. The Credit policy, as percieved by the stock markets, is supposed to be saying that there arent going to be any more rate hikes, GDP growth will sustain at 8.5-9% and inflation is under control. Banking scrips were on fire, logging in gains of 5-10% once the credit policy was announced. Hmmm ...
Lets take a closer look at what the Credit policy says .... but first, let me say that there was never a doubt that RBI wont hike rates on 24th April, for the simple reason that the earlier CRR hike was in two tranches, last of which is to come into effect from 28th April. So, with an impending hike yet to take effect in reality, do we really think the RBI would be stupid enough to go for another hike without seeing the effects of the already announced measures and have egg on its face ?? duh !
Okay ... back to what Credit policy says ...
GDP growth estimate lowered from 9-9.5% as the FM projected just couple of months back, to 8.5%;
Average price of crude basket for India at USD 64 as on 20th April 2007;
Money supply increased to 20.8% in 2006-2007;
No interest to be paid by RBI on CRR balances;
Forex reserves at USD 200 billion as at end March, 2007;
Prices of manufactured products account for well above 50% headline inflation;
Inflation to be contained close to 5% for 2007-2008;
Money supply to be contained at 17-17.5%
Now, lets put all these pieces together and try to create a complete picture. One, growth expectations lowered ... why ? is the demand slackening or are there supply constraints ? Neither ... GDP growth lowered as inflation control measures will effect growth as explained in an earlier post after the CRR hike. Two, crude prices still high around 64 USD a barrel and with rupee getting stronger by the day, crude will take the import bill down in rupee terms. But, the rupee would remain strong as long as the inflows are higher than demand for dollar, which is very much possible given the higher interest rates prevailing in India, which would in turn mean expanded liquidity, thereby reducing the effectiveness of current measures of RBI to contain inflation by tightening liquidity. End result ? more tightening with rate hikes ... its a vicious circle. Three, money supply, which is at 20.8%, to be brought down to 17-17.5%, which is a 15% reduction at the higher band. And how will that come into effect ? RBI will suck in more liquidity from the economy with further tightening. Four, at the current inflation rate of over 6%, RBI needs to see it fall over 15% to bring it down to 5% level it expects to maintain for current year. Also, RBI's comfort zone of inflation for next year is in the range of 4-4.5%. With price of manufactured goods accounting for over 50% of headline inflation as reported by RBI, what does the Guv need to do to bring down inflation levels within their target zone ? Finally, the punchline from RBI itself .... "to respond swiftly with all possible measures as appropriate to the evolving global and domestic situation impinging on inflation expectations and the growth momentum."
One doesnt need to be a rocket scientist to decipher what the RBI is saying, never mind what the markets 'read' into it. Interestingly, the public sector banks were the ones that went through the roof on tuesday ... while private sector banks were a bit sedate in comparision. So, where do we go from here ? I would estimate that if we dont see inflation come down in the next 2-3 of weeks to below 5.75%, we would see RBI flexing its muscles again with another rate hike, most likely around mid May 2007. The RBI hasnt changed its stance a wee bit, its still as hawkish as before. Only, it decided to sweet-talk its way this time and the reasons behind that could be much more complicated than what meets the eye.
Lets take a closer look at what the Credit policy says .... but first, let me say that there was never a doubt that RBI wont hike rates on 24th April, for the simple reason that the earlier CRR hike was in two tranches, last of which is to come into effect from 28th April. So, with an impending hike yet to take effect in reality, do we really think the RBI would be stupid enough to go for another hike without seeing the effects of the already announced measures and have egg on its face ?? duh !
Okay ... back to what Credit policy says ...
GDP growth estimate lowered from 9-9.5% as the FM projected just couple of months back, to 8.5%;
Average price of crude basket for India at USD 64 as on 20th April 2007;
Money supply increased to 20.8% in 2006-2007;
No interest to be paid by RBI on CRR balances;
Forex reserves at USD 200 billion as at end March, 2007;
Prices of manufactured products account for well above 50% headline inflation;
Inflation to be contained close to 5% for 2007-2008;
Money supply to be contained at 17-17.5%
Now, lets put all these pieces together and try to create a complete picture. One, growth expectations lowered ... why ? is the demand slackening or are there supply constraints ? Neither ... GDP growth lowered as inflation control measures will effect growth as explained in an earlier post after the CRR hike. Two, crude prices still high around 64 USD a barrel and with rupee getting stronger by the day, crude will take the import bill down in rupee terms. But, the rupee would remain strong as long as the inflows are higher than demand for dollar, which is very much possible given the higher interest rates prevailing in India, which would in turn mean expanded liquidity, thereby reducing the effectiveness of current measures of RBI to contain inflation by tightening liquidity. End result ? more tightening with rate hikes ... its a vicious circle. Three, money supply, which is at 20.8%, to be brought down to 17-17.5%, which is a 15% reduction at the higher band. And how will that come into effect ? RBI will suck in more liquidity from the economy with further tightening. Four, at the current inflation rate of over 6%, RBI needs to see it fall over 15% to bring it down to 5% level it expects to maintain for current year. Also, RBI's comfort zone of inflation for next year is in the range of 4-4.5%. With price of manufactured goods accounting for over 50% of headline inflation as reported by RBI, what does the Guv need to do to bring down inflation levels within their target zone ? Finally, the punchline from RBI itself .... "to respond swiftly with all possible measures as appropriate to the evolving global and domestic situation impinging on inflation expectations and the growth momentum."
One doesnt need to be a rocket scientist to decipher what the RBI is saying, never mind what the markets 'read' into it. Interestingly, the public sector banks were the ones that went through the roof on tuesday ... while private sector banks were a bit sedate in comparision. So, where do we go from here ? I would estimate that if we dont see inflation come down in the next 2-3 of weeks to below 5.75%, we would see RBI flexing its muscles again with another rate hike, most likely around mid May 2007. The RBI hasnt changed its stance a wee bit, its still as hawkish as before. Only, it decided to sweet-talk its way this time and the reasons behind that could be much more complicated than what meets the eye.
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