Slower growth plus higher interest rates?

Slower growth plus higher interest rates?
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First Published: Sat, Mar 29 2008. 01 00 AM IST

Updated: Sat, Mar 29 2008. 01 00 AM IST
Inflation has now shot up to levels where the central bank may be forced, in spite of slowing growth, to take action.
In recent days the government has also upped the rhetoric on inflation, to the extent that, as A. Prasanna, economist with ICICI Securities, put it, “it has boxed itself in.” At a time when growth is visibly slowing, that leaves the central bank on the horns of a painful dilemma.
As earlier, the main contributors to higher inflation have been non-food primary articles, up 14.6% year-on-year, food products, the prices of which have risen 8.2%, and basic metals and alloys, up 22.9% y-o-y.
Within the fuel group, naphtha prices have gone up a huge 33.2% y-o-y, while mineral oils are up 9.2%.
As the chart shows, inflation is a global phenomenon. But while it looks as if Indian inflation is at about the same level as it was a year ago, that view ignores the fall in prices last year and the subsequent spurt in recent weeks.
The Reserve Bank of India (RBI) may have to do something to curb inflationary expectations. The market on Friday was agog with talk of a hike in the cash reserve ratio, sending bond yields up to three-month highs.
Prasanna points out that April could be a good time to do that, since there’s usually a lot of liquidity in the market then.
The dilemma is compounded by the fact that it’s uncertain what impact monetary tightening will have. After all, the RBI’s actions have already resulted in bank credit growth slowing from 29.8% in January 2007, when inflation hit a two-year high of 6.69%.
At that time, bank credit was growing at almost 30% and it’s down to 22% now, with inflation at the same level.
There are other options, such as using the mountain of forex reserves to buy rupees, thus appreciating the currency and lowering landed costs. But the RBI has traditionally had reservations about using the currency to control inflation. Lowering excise duties will help, as will lower import duties. But, as mentioned above, some action by the RBI may be necessary to reduce inflationary expectations. It’s no coincidence that the BSE Bankex was the worst performer among the sectoral indices on Friday.
Primary market reform is long overdue
The Securities and Exchange Board of India’s (Sebi) plan to reduce the gap between a company’s book building via initial public offering (IPO) and its listing is a welcome move, but it’s also a reform that’s been long overdue. It’s something the Securities and Markets Infrastructure Leveraging Expert (SMILE) task force had recommended long ago. But then, better late than never.
Some experts feel there’s no reason why primary market transactions should take so much more time than a secondary market transaction. A trade on the stock exchanges gets settled two days after the trade, but it takes about two weeks since the close of the book-building of an issue for funds to get refunded and shares to get credited. The existing stock market infrastructure can be leveraged much more to curtail this time gap.
In a related move, Sebi is also planning to ask institutional players to make a 100% upfront payment while applying for an IPO. (Currently, they pay only a 10% margin.) While institutional players are certain to cry foul, since it involves locking up funds, the simultaneous move to cut the time involved with the IPO process would help. As pointed out earlier in this column on the issue of margining institutional players in the cash market, there’s no reason why they should be treated differently from other market players.
If Bear Stearns Companies Inc. could nearly go bankrupt over a weekend, it’s better to be safe than sorry and collect appropriate margins from all players.
As far as demanding upfront payment for IPOs is concerned, it would certainly curb institutional players from making overtly high subscriptions in the book building process. As a result, oversubscription levels should come down and the whole system would be better off, with non-genuine investors staying out. In a number of large issues such as Reliance Power Ltd, companies and bankers have made it easier for non-institutional investors by demanding only 25% of the bid amount as application money. The regulator should make sure that such allowances aren’t extended to circumvent the proposal for making 100% upfront payments.
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First Published: Sat, Mar 29 2008. 01 00 AM IST