The consensus at the moment is that inflation will remain high for quite some time and the central bank will be forced to tighten even further. The big question, however, is how much further will interest rates have to rise before the Reserve Bank of India can put a lid on inflation.
As a report from CLSA points out, “Asian central banks are perceived to be behind the curve in responding to the energy and food price shock, as reflected in the level of nominal interest rates in the region relative to headline inflation rates. Furthermore, in those countries with widening current account deficits, such as India and Korea, there is concern about further exchange rate depreciation caused by deteriorating terms of trade, which would further fuel inflationary pressures.”
As the table shows, real policy rates (policy rates less the inflation rate) are negative across Asia and the real rates in India are in the middle of the range. To get an idea of the kind of hikes in rates that are being prescribed, consider this: Morgan Stanley’s chief currency strategist Stephen Jen is reported to have recently said China needs to raise interest rates, currently near zero, by around 8 percentage points. But even if the Indian inflation rate falls to 10%, that’s still 1.5 percentage points more than today’s repo rate, banks can effectively borrow at negative real rates.
During the last oil shock in the late 1970s, Paul Volcker, who took over as chief of the US Federal Reserve in August 1979, hiked the Fed funds rate to 20% rapidly. Inflation in the US spiked to a high of 14.76% in March 1980 and by December, he had raised the Fed funds rate to 20%. The upshot was that inflation fell to 3.8% by December 1982. However, the impact on growth was equally dramatic: gross domestic product was a negative 1.9% in 1982. Asian central banks will have to choose the trade-off between growth and inflation. But, at the very least, they need to pull real policy rates into positive territory.
A smooth operation for Spice Communications
The erstwhile promoters of Spice Communications Ltd, led by B.K. Modi, have sold their 40.8% stake to Idea Cellular Ltd earlier this week through a block deal on the Bombay Stock Exchange. This will save them capital gains tax worth nearly Rs200 crore. The promoter group had bought the shares for Rs281.5 crore and sold them for Rs2,176 crore.
Long-term capital gains tax is waived when shares are transacted on a stock exchange, but is applicable at a rate of 10% on off-market transactions. While it’s a no-brainer that the former option is more tax-efficient, doing a block deal isn’t entirely straightforward. The deal can be struck only within a 1% band from the prevailing market price. So if the agreed price is much higher than prevailing rates, the share price would have to be deliberately pulled up and brought within the 1% band.
Thankfully for the BK Modi group and Idea Cellular, Spice shares were trading only about 6% lower than the agreed sale price of Rs77.30 a share. And in the process of pulling up the share price towards the 1% price band, Idea ended up buying two million shares (0.29% of the equity capital) at an average price of Rs74.81. Note that Spice’s minority shareholding stood at 20% prior to the deal and would now stand reduced by two million shares after the block deal. Now, Idea will have to buy two million fewer shares in the mandatory 20% open offer. And so the market operation hasn’t really cost anything.
But in the case of Ranbaxy Laboratories Ltd, whose promoters are expected to do a similar block deal with Japan’s Daiichi Sankyo Co. Ltd soon, there may be a higher cost attached. The agreed sale price of Rs737 a share is 37% higher than the current traded price. If it adopts the block deal route (which it most likely will because it stands to save Rs1,000 crore on tax), the share price would have to be pulled up by 36% by buying out all the outstanding sellers in the market, before the block deal is struck. As this column had pointed out on 23 June, this will provide Ranbaxy’s minority shareholders a unique opportunity to sell their shares at a higher price by placing sell orders in the market every day at about Rs725 each. And unlike Spice, where the minority holding is just 20%, Ranbaxy’s non-promoter holding is 65%. So accumulating shares from the open market will not reduce the number of shares that have to be bought in the open offer.
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