The Reserve Bank of India (RBI) has chosen to lean against the wind blowing through global financial markets by opting for status quo on rates and re-emphasizing potential pricing pressures in the economy. The policy enunciates risks to inflation from high food and fuel prices, sounds confident about the resilience of the domestic economy and is vigilant about the risk of financial contagion from global developments.
Nitin Jain, managing director and CEO, ICICI Securities Primary Dealership Ltd
For all practical purposes, the central bank has judged that this is not the right moment to act on the easing front. The policy comes across as more of a “hold” strategy rather than any short- or medium-term guidance. As the governor stated in the post-policy conference, the “simultaneity of multiple risks” unfolding in global markets makes it currently prudent to observe rather than act hastily. Further, the mention of need for better credit delivery by banks and some evidence of “demand slowdown at disaggregated level” buttress the view that RBI is not far away from adopting an easier credit regime. Indications of 8.5% GDP (gross domestic product) growth target for 2008-09 also point in the same direction as it looks unlikely to be achieved without any policy intervention.
One reaction to the policy statement is centred around the credible threat of global slowdown and softening domestic consumption demand. While inflation risks suggested by RBI are present and credible, price pressures are likely to subside in the face of significant demand shock in the developed economies. The US economy is facing near-recessionary conditions and other major economies are also facing significant downside risks to growth. On the domestic front, growth of goods exports, which has softened to 7.5% year-on-year, or y-o-y (in rupee terms) from 31.5% in the previous year, on the back of a strong currency will likely face slower demand from key markets in the coming months. Consumption demand has also slowed down to 5.6% y-o-y this year from an average 6.5% in the previous two years. Within consumption, demand for durables has taken a big hit from high retail lending rates. Production of durables has outright contracted by 1.7% year-to-date.
With export outlook weak and consumption demand softening, investment demand is left as the sole driver of domestic growth. While pent up capex demand and favourable equity market conditions augur well for the capex (capital expenditure) cycle, investment demand is, by nature, derived demand and may falter going forward, should global conditions worsen or domestic consumption continues to remain sluggish. In order to insure against this, it might have been prudent for RBI to signal a softer stance by cutting the repo rate (a key lending rate) by 25 basis points. However, for now, RBI seems comfortable with nudging banks to lower their rates without explicitly signalling a softer stance.
Towards this, RBI’s liquidity management in the coming months will be critical. It may be inclined to allow slight excess liquidity conditions by scaling back MSS (market stabilization scheme) issuances in the current quarter, setting the stage for banks to announce cuts in deposit and lending rates by the beginning of April.
Overall, it looks likely that it is only a matter of time before the central moves to a softer credit regime. Bond markets are unlikely to give up all the gains made during the course of the month and will likely wait for a trigger to rally further.
Nitin Jain is managing director and CEO, ICICI Securities Primary Dealership Ltd.