Slowdown concerns persist

Slowdown concerns persist
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First Published: Tue, Apr 29 2008. 11 31 PM IST

Updated: Tue, Apr 29 2008. 11 31 PM IST
Will the 25 basis points hike in CRR (cash reserve ratio, the balance banks need to keep with the central bank) reduce inflation? Of course not. Why then did the Reserve Bank of India (RBI) do it? Most observers have said that it’s aimed at managing liquidity.
The call money rate is 6%, at the bottom of the 6-7.75% corridor in which the central bank accepts overnight deposits and lends overnight money. RBI’s aim is to suck out enough liquidity to take this overnight rate nearer the repo rate of 7.75%. Only then would a repo rate hike become effective.
But liquidity is abundant at this time of the year since this is the slack season and credit growth is usually very low or negative in the first few months of the fiscal year. So it is by no means certain that the CRR hike will be enough to meet RBI’s objective.
The bond as well as the stock markets staged a relief rally, happy that their fears of a repo rate (the rate at which RBI lends to banks) hike have not been realized. But banks will be hurt by the additional impounding of resources under the CRR, on which no interest is paid. And if this CRR hike is not enough, as is very likely, there is the certainty of future tightening.
RBI’s target for non-food credit growth, including bank investments in corporate paper, at 20% for 2008-09 is well below the current growth (as on 11 April) of 23.87% in this metric. That doesn’t augur well for banks. Nor is it at all certain whether public sector banks will be allowed to raise lending rates.
Interest rates on auto loans have already hardened and the y-o-y growth in housing loans is down to 12%, although there’s a reduction in risk weight for some housing loans.
In short, there’s no reason for stock market euphoria in the interest-rate sensitive sectors.
In the bond markets, uncertainty about further tightening will persist unless there are clear signs of lower inflation. On Tuesday, the markets were merely thanking the RBI governor for not making it worse.
What about inflation? The monetary policy statement says: “There are concerns that demand pressures, which have been reasonably contained so far, are being coupled with supply-side factors which, if not temporary, could impact domestic inflation significantly.”
So why didn’t RBI adopt a tougher stance? Possibly because they’re worried about the slowdown, despite the brave talk of GDP (gross domestic product) growth being 8-8.5% this fiscal.
Much will depend on capital inflows into the country. Data for the last two months (15 February to 11 April) show that, despite the slowdown in FII (foreign institutional investors) inflows, foreign exchange assets with banks rose by Rs85,556 crore, compared with Rs51,620 crore over the same period last year. The recent modest return of risk appetite, if it persists, could lead to further tightening, especially since RBI seems to be reluctant to use the currency to moderate inflation.
As for inflation, most forecasts expect it to stay at elevated levels, although the recent supply-side measures taken will help. IMF (International Monetary Fund) projections put the global commodity price index, which was at 134.9 in 2007, at 165.3 this year.
For some indices, such as the coal price index or the cereal price index, the increases persist in 2009. However, all eyes are on the US Federal Reserve.
The December 2008 futures contract is currently pricing in the Fed funds rate at around 2%, implying that the market expects the Fed to pause after a 25 basis point rate cut on Wednesday. If that happens, the hope is that the dollar will firm up and commodity prices cool, taking some of the edge off inflation.
Tax holiday extension gives relief to IT companies
Software services stocks rallied on average by about 5% after the government decided to extend tax sops for units that operate in software technology parks (STPs) by a year.
The incentives were supposed to end in fiscal year 2008-09, and analysts had estimated that the effective tax rate for large software companies would rise to about 22% in fiscal 2010, up from about 13-15% currently.
That gets extended by a year now.
Profit estimates for 2009-10, as a result, will rise by about 9-11% for large firms.
It would be naïve to infer that stock prices should also rise by the same measure to reflect higher earnings. After all, the higher profit applies for only one year and is not recurring. The impact on company valuations based on discounted cash flow, therefore, will be minimal.
The fact that some stocks rose by as much as 8-10% is more a reflection of the upswing in investor sentiment.
Not that the move isn’t beneficial for software companies. Some companies have been slow in setting up new units in special economic zones, to keep tax rates low even after the STP sop lapses.
The one-year extension gives some more breathing space.
Also, keeping in mind the slowdown in US economy and its expected impact on profit growth, it’s heartening to note that the blow of higher taxes will be dealt only two years later.
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First Published: Tue, Apr 29 2008. 11 31 PM IST