The Reserve Bank of India’s quarterly review was a clear attempt by the central bank to reassert its control over wayward money markets.
Abundant liquidity had led to a situation where short-term yields were well below the policy rate and the call rate was close to zero. This was completely at odds with RBI’s stated monetary policy stance.
By removing the daily cap on the reverse repo (the amount that the RBI will accept overnight money from banks), the central bank has, at one stroke, ensured that the minimum money market rate will now be the reverse repo rate of 6%.
The central bank’s policy of keeping short-term rates within the liquidity adjustment facility (LAF) corridor, bounded on the downside by the 6% reverse repo rate and on the upward end by the repo rate of 7.75% (the rate at which banks can borrow overnight from RBI) has thus been reinstated.
“The RBI is telling the market, ‘We are in control and any deviation from our policy will be at your own risk. We have plenty of ammunition to enforce our policy’,” said Indranil Pan, chief economist with Kotak Mahindra Bank Ltd.
The bond markets were taken by surprise and bond yields hardened, with the biggest jump being at the shorter end of the market. The hike in cash reserve ratio (CRR) is an added precaution.
“A CRR hike alone would not have been enough to move short-term rates sharply upward, given the liquidity in the system,” said Gaurav Kapur, economist at ABN Amro Bank in Mumbai. “The RBI had no option but to protect its credibility,” added Chetan Ahya, India economist with Morgan Stanley.
So, what will be the impact of these measures?
In the bond and credit markets, short-term yields have already risen sharply and that will immediately increase the cost of short-term borrowing and rates on commercial paper will go up. However, since the measures are aimed not at increasing interest rates further but to ensure that they don’t go down, interest rates on bank loans may not go up.
In the forex market, RBI’s actions are being interpreted as a sign that it will continue to intervene in the market. “The rupee is already overvalued by 12% according to RBI’s real effective exchange rate,” points out Ajit Ranade, chief economist with the Aditya Birla group.
In the stock market, after an initial knee-jerk reaction, bank stocks rose. Those banks with surpluses to lend in the money markets will gain, while borrowing banks will lose.
Whether the gain is enough to offset the burden of a higher CRR will depend on the bank’s liquidity position. Interest-rate sensitive stocks have moved up on hopes that interest rates had peaked. That may well be the case, but the downward journey from that peak will have to wait.
Tata Motors disappoints
Tata Motors Ltd reported single-digit operating margins, perhaps for the first time since it returned to the black in late 2001. Operating profit stood at Rs546.3 crore, or 9%, of sales after excluding for gains on account for forex exposure.
Similar data which takes out forex gains is difficult to find for past quarters. But data collated by Capitaline shows that ever since Tata Motors returned to the black in the March 2002 quarter, operating margin has consistently been above 10.5%. The drop in margin last quarter led to a 20% drop in operating profit.
The disappointment with the company’s June quarter results isn’t restricted to the drop in profitability.
Sales of medium and heavy commercial vehicles in the domestic market fell by about 11%, leading to fears that perhaps a high base is finally catching up. In the year-ago June quarter, such vehicle sales had jumped 59%. One of the reasons for the fall in such vehicle sales is the shortfall in supply of a critical component. But analysts say there are other reasons as well for the drop in sales. The ban on overloading last year had led to a sharp rise in sales, after which truck operators are going slow on capacity addition. What’s making it worse for operators is that freight rates have dropped. While the cost of operations has risen primarily due to higher interest costs.
Besides, competition from the railways has increased. The performance of the passenger car division hasn’t been too inspiring either—sales rose less than 5%, with the company losing share in the compact car segment. The disappointment with the June quarter results could lead to some earnings revisions and hence an adjustment in the company’s shares.
One positive from the results was the performance of subsidiary companies. On a cumulative basis, their sales rose 60% and operating profit jumped by 129%. But the markets would be more interested in the core auto business, which accounts for 80% of revenues, and this segment has clearly disappointed.
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