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Near The End Of A Cycle?

Business World Nov 08, 2014

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[The Reserve Bank of India (RBI) has affected its twelfth rate hike in a row with Friday's hike of 25 basis points (bps) in the repo rate taking it to 8.25 per cent.  Yet somehow, there is a feeling that we might be at the end of the rate tightening cycle. The central bank's forward guidance says its stance will be influenced by signs of downward movement in the inflation trajectory, to which the moderation in demand is expected to contribute, and the implications of global developments. "The guidance suggests to us that the RBI has shifted from a strong anti-inflationary bias to a more wait-and-see mode, with a close eye on the inflation trajectory and global developments", says Tomo Kinoshita at Nomura Financial Advisory and Securities (India). The Tide Is Changing So is this the last hike by the RBI? Kinoshita thinks so. Global commodity prices have remained stable in the last few months. This is likely to reduce supply-side inflation pressures. Secondly, the effect of past monetary tightening actions will be seen in the coming months. "The key risk to our forecasts is a surge in food or commodity prices. A further deterioration in global growth constitutes a key downside risk", adds Kinoshita. Ironically, even those who criticise the central bank's latest hike actually confirm the view that we are towards the end of the rate-hike cycle. "The arguments for the hike were backward rather than forward looking. The RBI continues to believe that growth momentum is weakening, that inflation will fall in the second half of the fiscal; that global developments are a matter of serious concern", says Tushar Poddar, economist at Glodman Sachs.  "We think that inertia in policy-making -- once the central bank is on a tightening cycle, it is difficult for it to stop, was probably responsible for this hike", adds Poddar. The RBI governor, Dr Duvvari Subbarao, appears to be less hawkish: "A premature change in policy stance could harden inflationary expectations, thereby diluting the impact of past policy actions". It's a reference to the clamour in the run up to the Policy Review that the worst may well be behind us; and it is better to hold back from further tightening. Rao's words can be interpreted thus -- if the central bank were to hold its monetary policy fire, it may lull the market into believing the worst is behind us. But it also tells you that you may well be on cusp of a change -- the fight against inflation is at its last stage. The good doctor's prescription of a heavy monetary dosage will be continued lest there be a relapse. Worse still, a premature pull back at this point in time from rate hikes can also give rise to the view that policy actions so far have failed to deliver in so far as curbing inflation is concerned. After all, inflation as measured by wholesale price index rose year-on-year (YoY) to 9.8 per cent in August 2011, up by 60 bps in July; the same in manufactured products rose by 20 bps to 7.7 per cent, indicative of demand pressures. A large part of the inflation — caused by food and high crude oil prices -- are out of firing range of the central bank. It can, at best hope a tight monetary policy will reduce the consumption of certain kinds of foods or that you and me will not cut down on petrol. And, therefore, the Rs 3.14 per litre hike in petrol effective from the 16th of this month will also add 7 bps to headline inflation. More Than Just Monetary For the Congress-lead United Progressive Alliance (UPA), the stakes are high. It is well into its second innings; anti-incumbency has set in early. It has lived from crisis to crisis since it was returned to power in the summer of 2009. Uttar Pradesh goes to polls in the first half of 2012; it is seen as a semi-final ahead of the big showdown in 2014. Gujarat goes to the hustings later next year. It cannot afford to have inflation anywhere near its current levels or its aam aadmi bugle will croak. There's another headache. In the run up to 2014, UPA-2 will be tempted to go in for populist measures. The central bank is worried the fiscal deficit -- at 55.4 per cent of budget estimates in the first four months of the current fiscal — is significantly higher than that of 42.5 per cent during the corresponding period last year (when adjusted for the more than budgeted spectrum proceeds). The Rs one-lakh crore earned from the 3G auction and something more has been consumed. A tight interest rate regime can spoil the plot further with India Inc's earnings taking a hit (less by way of taxes); there is also less by way of receipts given the dead disinvestment programme. "Fiscal policy earned a paragraph in the statement with the RBI understandably not happy about fighting a lonely battle against inflation with the fiscal stance at a risk of being looser than planned if the government does not counter the slippage on the revenue and spending side (subsidies)", says Leif Eskesen, Chief Economist (India & ASEAN) at HSBC. The impact of the RBI's past rake hikes is yet to result in lower inflation. "Even if month-on-month pressure on core inflation begins to subside hereon, overall inflation could reach only about RBI's projection of 7.0 per cent by March 2012 -- still above the comfort zone of 5.0 to 5.5 per cent", notes Ajay Srinivasan, Head-CRISIL Research. Non-food credit grew at 20.1 per cent YoY in August above the projected 18 per cent in the July policy review. But this growth is much sharper "if you are to adjust for the credit disbursement to telecom companies for the purchase of 3G spectrum", as Madan Sabnavis, chief economist at CARE Ratings points out. But if you consider it another way, the central bank's moves seem to have paid off. With a moderation in credit off-take due to higher interest rates, and a relatively higher growth in deposits, the incremental credit-deposit ratio (the amount you a bank gives out as loans out of every Rs 100 in deposits) declined to 82.7 per cent on August 26, 2011 from 97.2 per cent on March 25, 2011. The RBI knows something we don't. Points out Poddar: "The RBI would not give a dovish statement to make future action dependent on data. Though another rate hike cannot be ruled out, we think that the underlying slowdown in momentum in the economy, weakening inflationary pressures, and global headwinds make the bar for another hike high. We continue to expect 100 bps of rate cuts in fiscal 2013". Because there will be a big price to paid in 2014.