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Motilal Oswal

By Motilal Oswal 02-Jun-2010 | 10:57

In the back drop of the European crisis, I expect that world recovery will lose some momentum in 2010-11 but I do not anticipate that the recent turmoil in the markets will derail the global upswing. The implication for Asia is that the regional rebound will slow rather than stall and it remains likely that growth will stay far higher than elsewhere. Accordingly, Asian central banks will be focused on inflation. Policy rates will move up further and most countries will be nearing the end of their tightening cycles well before rate hikes even start in the US and in Europe. Finally,I would like to forecast that Asian currencies and stocks will end FY11 stronger and higher than where they finished in FY10.


In India, Q4FY10 has most certainly climbed following a weak Q3 which was caused by a slump in agriculture. In coming quarters, I expect that GDP will continue to climb at a 8-9% q-o-q annualized pace, even as fiscal stimulus measures are pulled back. There is very little spare capacity and corporate profitability is strong. Private investment should pick up while industrial output and consumer spending should be supported by ongoing infrastructure improvement projects, rapidly rising household incomes and increased bank lending


The Government is committed to cutting the budget deficit. The fiscal shortfall and the overall level of government debt at 82% of GDP remain quite high. Nonetheless, financing problems are unlikely. The prospects of continued high nominal GDP makes debt ratios manageable . The liabilities are also overwhelmingly owned by on-shore institutions. This means that India especially is not vulnerable to shifts in foreign investor sentiments . In addition ,the 3G license auction which generated almost double the target and the equivalent of around 0.5% of GDP, has also made the government borrowing programme less daunting


I remain very firmly bullish. Bull markets works the best when doubted the most. With interest rates closer to zero and expected to remain so in the developed countries around the world for years, there is a limit to which equity markets can fall. Every correction should be used as a buying opportunity . Real estate stocks should surprise most analysts on the upside . Just wait and watch


1. INDIAN ECONOMY: RBI RAISES POLICY RATES TO CONTROL INFLATION; WILL REVIEW POLICY TWICE A QUARTER THE MEASURES

  • Increase in the Repo rate by 25bps to 5.75% as per expectations.
  • Increase in the Reverse Repo rate by 50 bps to 4.50% vs expectations of a 25bps hike.
  • CRR has been left unchanged as expected.
  • The FY11 GDP growth estimate has been enhanced by 50 bps to 8.5% (from 8% with an upward bias as per April Policy) as per expectations.
  • Similarly the March 2011 inflation estimate has been enhanced by 50 bps to 6.0% (from 5.5% as per April Policy) as per expectations.
  • No extension granted to the daily second LAF facility as per expectations.
  • Monetary stance is substantially altered to give ascendancy of inflation control in policy priority as per expectations.
  • Although RBI has taken mid-course corrective actions in the past and retains the right to do so even now, somewhat unexpectedly, the RBI has increased the frequency of review of its policy to one and half months from a quarter at present.

RBI RAISED SHORT TERM LIQUIDITY MANAGEMENT RATES - BROADLY IN LINE WITH EXPECTATIONS – MILD SURPRISE ON REVERSE REPO

2. RBI NOTED THAT THE MARKET MOVING IN THE REPO MODE ACTED AS ANAUTONOMOUS TIGHTENING OF MONETARY CONDITIONS BY 150 BASIS POINTS 


3.RBI’S ASSESSMENT AND EXPLANATION

  • Global growth and inflation has been multi speed. Visible soft spots in Europe and the US contrasts with relatively rapid recovery in EMEs accompanied by faster growth in prices. Global growth in the second half of 2010 will be lower than that in the first half. Global inflationary pressures are expected to be subdued over the next few months.
  • On the domestic front, the recovery has consolidated and is becoming increasingly broad-based. The strength of the recovery is also reflected in the sales and profitability growth of the corporate sector. Besides replenishment of inventories, investment intentions are being translated into action across sectors, particularly in power, telecom and metals. However, if the global recovery slows down, it will affect all EMEs, including India, through the usual exports, financing and confidence channels.
  • The recent partial deregulation and increase in administered prices of petroleum products is welcome from long-term fiscal consolidation and energy conservation perspective. Nevertheless, it will have an inflationary impact in the short term of 1% immediate impact followed by second round impacts in coming months.
  • Food price inflation has remained at an elevated level for over a year now, reflecting structural bottlenecks in certain commodities such as pulses, milk and vegetables. The Reserve Bank’s quarterly inflation expectation survey conducted during the first fortnight of June 2010 indicates that short-term inflationary expectations have increased marginally.
  • Notwithstanding the current inflation scenario, it is important to recognise that in the last decade (2000-01 to 2009-10), the average inflation rate, measured both in terms of WPI and CPI, moderated to around 5 per cent from the historical trend rate of about 7.5%. Against this backdrop, the conduct of monetary policy will continue to condition and contain perception of inflation in the range of 4.0-4.5%. This will be in line with the medium-term objective of 3.0% inflation consistent with India’s broader integration into the global economy.
  • The main risk of RBI’s assessment emanates from the global scenario and has two key dimensions. First if the global recovery falters, the risk of which has increased since the April 2010 policy announcement, the performance of EMEs is likely to be adversely affected. The more significant risk, though, is from a potential slowdown in capital inflows. India’s rapid recovery has resulted in a widening of the current account deficit, as imports have grown faster than exports. Apart from narrowing the comfortable buffer between the current account deficit and net capital inflows, this may constrain domestic investment, which is critical to achieving and sustaining high growth rates.
  • Current market conditions indicate that while liquidity pressures will ease, the system is likely to remain in deficit mode for now.
  • There is no unique way to determine the appropriate width of the policy interest rate corridor. But the guiding principles are: (i) it should be broad enough not to unduly incentivise market participants to place their surplus funds with the central bank; (ii) it should not be so broad that it gives scope for greater interest rate volatility to distort the policy signal.
  • Rough estimates show an improvement in the total flow of financial resources from banks, non-banks and external sources to the commercial sector during 1QFY11 (to Rs2,500 bn as against Rs610 bn during 1QFY10). Disaggregated data suggest that credit growth to all major sectors such as agriculture, industry, services and personal loans had begun to improve from November 2009 onwards.
  • The 10-year benchmark government security fell to 7.59% in June 2010 from 8.01 per cent in April 2010in the expectation that the Government will reduce market borrowing because of higher realisations from spectrum auctions. Subsequently, the yield moved up to 7.73% by the third week of July 2010. Of the budgeted net market borrowing of the Central Government for FY11 at Rs.3,450 bn, about 38.5% (Rs.1,329 bn) of the borrowing was completed by mid-July 2010.
  • The foreign exchange market saw volatility increase relative to the previous quarter, with the rupee showing two-way movements in the range of Rs.44.33-Rs.47.57 per US dollar. During 1QFY11, both the nominal and real effective exchange rates (NEER and REER) have appreciated.



TAKEAWAYS FROM THE POLICY MEASURE AND RBI’S ASSESSMENT

  • With the policy rate hikes, change in stance and the outline of liquidity conditions, the RBI has done its bit for inflation control. Importantly, RBI has reiterated its resolve to contain inflation perception in the range of 4.0-4.5% and the medium-term objective of 3% inflation set out earlier conducive to India’s integration with the global economy. The strong stance is important in view of the July inflation quoted (press reports) at 11% (as against our estimate of 10.2%) by India’s Chief Statistician Mr. T.C.A. Anant. RBI’s move is therefore imperative and is expected to anchor inflationary expectations at the margin.
  • The reduction of the LAF corridor from 150 bps to 125 bps is attempted as an additional measure to contain volatility of short term rates and push the minimum rates up. The market being in repo mode and expected to be so for some time makes the measure more of a signal of anti inflationary resolve of RBI. The instrument, however, would become functional when the system returns to excess liquidity again or for those institutions that turns liquid faster than others. 


RBI’s MEASURE IS TIMELY IN VIEW OF EXPECTED DOUBLE DIGIT INFLATION IN JULY

  • The change in monetary stance of RBI is instructive. While interest rate regime has gained ascendancy in policy priority in lieu of liquidity management, short-term liquidity management would be in focus in place of ensuring adequate provision of liquidity for credit growth. In our view this is indicative of the shift in focus from short-term liquidity situation (which would continue to be actively managed) to long-term liquidity situation which might become stressful going forward.

CHANGES IN POLICY STANCE OF RBI – INTEREST RATE REGIME AND LIQUIDITY MANAGEMENT ALTERS POSITION, LIQUIDITY OBJECTIVE CHANGED MATERIALLY