What does the Reserve Bank of India’s (RBI) monetary policy statement mean for the stock, bond and forex markets? RBI’s changed priorities can be seen from the central bank’s statements on its monetary policy stance in April and now.
In April, the three objectives, in order of priority, were to 1) enable credit expansion, 2) to monitor conditions to swiftly address adverse developments and enforce positive ones and 3) maintain price and financial stability.
In its June statement, the stance has shifted to, in order of priority, 1) managing liquidity to meet both government ends and private sector demand, 2) keep a vigil on inflation and be ready to respond swiftly and 3) maintain price and financial stability.
The contrast between the two stances is marked. At the moment, the Centre’s huge borrowing programme is obviously top of mind for RBI. And the return of inflation is the second worry.
Not that RBI is terribly bullish on growth either. All it does is talk about 6% growth “with an upward bias”. That’s well below the forecast by the Prime Minister’s economic advisory council of 7% growth or those being made by Montek Singh Ahluwalia, the deputy chairman of the Planning Commission, or indeed by the finance minister.
The policy is in fact saying that gross domestic product (GDP) growth in FY10 will be lower than last year’s 6.7%.
The question the stock markets should be asking is: if RBI is right, where’s the V-shaped recovery? Why, even during the third and fourth quarters of FY09, GDP growth was 5.8%. So where are all those earnings upgrades going to come from?
For the bond markets, here’s the dilemma: as ICICI Securities Ltd’s economist A. Prasanna points out, banks’ credit-deposit ratio when the economy was coming out of the post-dotcom recession was much lower than at present.
For instance, at the beginning of July 2003, the credit-deposit ratio was around 54. At present, it’s 69.5. That means the pressures on interest rates to harden are much more at present, without even the government’s gargantuan borrowing. Gaurav Kapur, senior economist at ABN Amro Bank NV, points out that “projection of bank credit growth remains unchanged at 20% from its April projection. This seems to suggest that the central bank expects a pickup in bank credit offtake in the second half of the fiscal year.”
Hence RBI’s decision to raise its money supply growth forecast. As for kickstarting investment growth, RBI has said bank lending rates have scope to reduce further.
Most dealers do not expect long-term yields to rise significantly in the next six months and a rate hike is being forecast early next year. Prasanna points out that the yield curve is already steep, limiting further increases in yields at the long end. But since rate cuts are over and interest rates will rise, the medium-term appeal of bonds too goes out of the window.
The end of rate cuts also “takes away a small overhang on the INR”, say Goldman Sachs chief economist for India Tushar Poddar. With continuing capital inflows and a weak dollar, the upward pressure on the rupee is likely to continue.
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