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RBI readies for a decisive change as market jitters

RBI readies for a decisive change as market jitters
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First Published: Mon, Apr 02 2007. 05 26 PM IST
Updated: Mon, Apr 02 2007. 05 26 PM IST
Mumbai: The markets went into a tailspin on 2 April, with the benchmark Bombay Stock Exchange Sensitive index recording the biggest one-day drop since 18 May 2006. In a day marked by weak sentiment following the Reserve Bank’s decision to hike the cash reserve ratio and the repo rate, the Sensex shed 616.73 points, or 4.94%, to close at 12,455.37.
The National Stock Exchange index Nifty lost 187.95 points, or 4.92%, to close at 3,633.60.
With the exception of Reliance Communication Ventures, which was up 4.31% to Rs466.35, all the market prices of all other stocks comprising the Sensex fell. The biggest losses were seen in the auto, banking and housing counters, Maruti Udyog topping the list, losing 8.09% to close at Rs753.40.
Other big losers included Tata Motors (8.04%, Rs669.25) Hero Honda (6.68%, Rs639.35), State Bank of India (6.31%, Rs930.25), HDFC (5.77%, Rs1,432.70), ICICI Bank (5.70%, Rs804.50) and HDFC Bank (5.03%, Rs901.60).
The Reserve Bank of India had surprised the markets with a 25 basis point rise in its main lending rate on 30 March and with a clear-cut declaration that fighting inflation now came first.
For a central bank seen as being pro-growth for the past couple of years, this was a decisive change — even though the question of how much more tightening is needed has become murkier.
“This implies the central bank is now willing to make the trade-off and is ready to sacrifice near-term growth to address price stability,” said Chetan Ahya, economist at Morgan Stanley.
Ahya said the RBI was concerned about a domestic imbalance, reflected in actual growth being higher than potential growth.
“We believe it would be comfortable dropping its guard only on evidence of a correction in the imbalance between current domestic demand and supply.”
The central bank increased its main lending rate by 25 basis points to 7.75% and said it was jacking up the amount of funds banks must deposit with it for the third time in four months. The rate rise was the fifth in the fiscal year that ended last week.
The RBI also had this to say: “The stance of monetary policy has progressively shifted from an equal emphasis on price stability along with growth to one of reinforcing price stability.”
Compare that to previous RBI statements:
— Last April it spoke of “a monetary and interest rate environment that enables continuation of the growth momentum”.
— In October it tweaked that to say the rate environment had to support “export and investment demand in the economy”.
— By January it emphasised price stability but said this was while still supporting export and investment demand.
Many in the market have been expecting more tightening, largely because inflation and credit growth are running above the central bank’s comfort zone and because it has been intervening to keep the rupee down, feeding unwanted funds into the system.
But most had expected a move closer to its next review on April 24. Some said that while the action on 30 March complicated what might now happen at the end of the month, they did not rule out further measures to tackle rising credit and prices.
Hurry to grow
The economy, Asia’s fourth largest, is forecast to have grown 9.2% in the year ended 31 March.
That would be its fastest pace in 18 years and higher than the 6.5-8% rate which economists say is the country’s more natural speed while it works on improving its transport network and farm output, both struggling to keep pace with surges in imports, activity and demand.
But 9-10% growth has been a mantra for the government, which needs higher revenues to lift 22% of the 1.1 billion population above the poverty line, lower its fiscal deficit and allow spending on infrastructure.
Wholesale price inflation is running at 6.5% annually, well above the central bank’s projection of 5.0-5.5%. On other measures, prices are rising at more than 9% a year.
“The accelerated pace of rate tightening hints of the bank’s growing concern that it has fallen behind the curve,” said Manas Paul, economist at HSBC, in a research note.
Demand growth had been allowed to exceed supply for sometime, he said, leading to higher inflation. HSBC now expected another quarter point rise in the repo and a half point increase in the cash reserve ratio in 2007.
“Though we doubt the bank has finished tightening yet, this move obviously reduces the chances of anything happening at the April meeting. The difficulty now would be to determine when enough is enough,” he said.
Reactive not proactive
Rajeev Malik, economist at JP Morgan in Singapore, said the central bank was being reactive rather than forward-looking as many expected headline inflation to soften from April onwards.
Over the past year, the finance minister has tried to talk down expectations that inflation and rates may be going up, but his tone changed as inflation, particularly food prices, picked up.
The government slashed import duties to ease pressures but the ruling Congress party was punished in regional elections in February, with high prices partly blamed.
Malik said that while he doubted there would be another rate rise, he said there could be another increase in the reserve ratio if foreign inflows remained strong.
The central bank has tried to keep the banking system tight in recent months to deter riskier lending and to get banks to boost deposits. Lending has been growing at about 30% a year.
Last week, the overnight interbank rate hit 80% as banks short of collateral were unable to tap the central bank’s funding window and turned to the money market instead.
Malik said cash conditions were expected to improve as government spending picked up in the new fiscal year.
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First Published: Mon, Apr 02 2007. 05 26 PM IST
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