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Will RBI opt for a pause?

Will RBI opt for a pause?
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First Published: Thu, Aug 11 2011. 12 59 AM IST
Updated: Thu, Aug 11 2011. 12 59 AM IST
Mumbai: India’s central bank, which has been largely worried about inflation over the past two years, may now have something more to worry about, say economists and analysts—growth.
Still, they add that it’s unlikely that the debt crisis in Europe and the downgrade of the US by rating agency Standard and Poor’s will force the Reserve Bank of India (RBI) to reverse its stance of keeping money tight.
To be sure, the debt crisis and the downgrade could affect the investment climate in India, but the experts say that RBI’s primary focus is still inflation, which is expected to remain high.
Wholesale inflation was 9.44% in June and is not expected to slow before October. In its quarterly review of monetary policy, RBI has, in fact, raised its inflation projection. It expects inflation to peak at 9.5% before slowing to around 7% by March next year.
The central bank, the economists say, will not be blind to the drop in business confidence of companies that may revise their expansion plans in a slowing economy.
In other words, concerns about growth will be back on RBI’s radar along with managing price stability. “It’s too early to say whether RBI will press the pause button, but it is definitely concerned about the deteriorating investment climate—which had not been the case till recently,” said one economist, who did not want to be identified.
In July, the business confidence index survey, conducted by various agencies appointed by RBI, showed a moderation in optimism because of the rising cost of money.
RBI has raised its policy rate 11 times since March 2010, from 3.25% to 8%, in an attempt to contain inflation.
The capital goods component of the Index of Industrial Production (IIP, a measure of factory output) has been falling steadily since the start of the year. It grew by 20.2% in December; by May, growth had slowed to 5.9%.
Investment in India may not be dependent on interest costs alone, but investor sentiment is taking a beating. “Investment has been anaemic for several quarters and funding costs are not the key constraint because they were deeply negative through all of 2010 and are still significantly below historical averages,” said Sajjid Chinoy, India economist of JPMorgan India Pvt. Ltd.
“The fact that inflation has remained stubbornly high for over a year, the rate cycle has not peaked and no one is really sure to what extent growth will need to slow to reverse inflationary pressures, has (led to) uncertainty and deterred investment,” he added.
The desire to invest has also tapered off due to governance and regulatory issues, especially those related to land acquisition and environmental laws.
“(The) current global uncertainty is likely to exacerbate this dynamic,” Chinoy said.
According to analysts, the focus for now will be on the recovery in the US economy.
Global equity markets are in free fall and commodity prices, too, have fallen in the last week. With worries of a double-dip recession in the US intensifying, crude has cooled off from its April high of $124.9 per barrel to $104.5 per barrel as of Wednesday, a decline of more than 16%.
Similarly, the prices of most industrial metals have gone down. As have most asset classes, with money moving to gold. Continuing its rally, gold was up 1.72% at $1,770 per ounce (28.35g) in London as global stocks and commodities continued to tumble.
Analysts say RBI will have to wait and watch how the situation pans out, but will keep a close watch on the liquidity front. The domestic factor, though, will outweigh external factors.
So far, domestic markets—both equity and debt—have shown resilience and experts claim this is an indication that India is still an economy driven by domestic demand.
The Indian stock market has been among the worst performers since the beginning of the year with the country’s bellwether equity index, the Sensex, losing 17%.
Since last week, though, the Indian market has fared far better and beaten 14 of its peers.
According to Morgan Stanley, India has outperformed other emerging markets in a four-week period and is rated “underweight”. From a fundamental point of view, the investment bank is bullish on the country.
On the money-market side, overnight call rates have remained stable at 8%. Yields in the domestic bond market have fallen, tracking US treasury yields, but the market will be more driven by supply concerns, rather than any global slowdown scare.
Bond market yields have gone to their pre-policy level, when RBI hiked its rate by 50 basis points in July, but the rally could have been overdone and yields may rise again, said Prasanna Patankar, senior vice-president at STCI Primary Dealer Ltd, a bond trading house. One basis point is one-hundredth of a percentage point.
Yields on 10-year bonds should move between 8.15% and 8.35%, said Patankar, adding that the market is expecting Rs 50,000 crore of additional borrowing by the government as it looks likely to miss its divestment target of Rs 40,000 crore and tax collection could fall in a slowing economy.
There appears to be confidence and resilience in the financial markets here after RBI reassured investors that the country has enough ammunition, in the shape of foreign exchange reserves, in case of a spillover of the global financial turmoil.
In 2008, following the global credit crisis, funds worth $12.18 billion left the country. Among other things, RBI pumped in forex liquidity through a dollar swaps line.
ING Vysya Bank Ltd’s economist Deepali Bhargava warned that dollar liquidity in the country is again low. She expects additional dollar swap facilities by RBI.
“For India, domestic dynamics have always been more important than the global situation,” argued Bank of Baroda chief economist Rupa Rege Nitsure. “Inflation is not going to come down before October and RBI cannot afford to exercise a pause in rate hikes unless the global economy ‘goes for a toss’.”
“The government may take advantage of a slowdown in crude prices and introduce reforms like freeing up of oil prices from subsidies. This will be easier done in a lower crude price scenario, but that does not correct inflation in its present form,” Nitsure said.
According to Bhargava of ING Vysya Bank, RBI may stand to lose its momentum in attacking inflation if it exercises a pause in its mid-quarter policy in September.
“If they pause this time and if inflation goes up further for that, it does not help the situation if RBI goes on for a hike after that,” she said.
Samiran Chakraborty, head of India research at Standard Chartered Bank, said the key component to look out for is how the oil prices react after this slowdown.
Since the US Federal Reserve has projected dim growth rate for the American economy in the next two years, the demand slowdown may correct the commodity prices.
This will be an important input for RBI policymaking. But that may not be evident in some time to come.
A. Prasanna, chief economist at ICICI Securities Primary Dealership Ltd, said RBI may go for a pause in September. According to him, the core inflation has already peaked and RBI has hiked the policy rate quite a bit.
“I don’t think the global uncertainties will have much material impact on India. RBI has hiked its rates quite a bit and it can now afford to wait and see what the impact of those hikes will have on the economy,” he said.
Ashwin Ramarathinam and Vyas Mohan contributed to this story.
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First Published: Thu, Aug 11 2011. 12 59 AM IST