Rama Krishna Vadlamudi, BOMBAY April 17, 2010

"Lender of the Last Resort"

This is the most apt phrase that has been used in the past to
describe a central bank in any country. However, central banks do
not only this but also several functions, like, monetary policy, price
stability, stimulating the growth drivers in the economy, currency
note printing and acting as money manager for the governments,
among other things. Due to several upheavals in the financial
world, the role of central banks has transformed a lot lately.

"Market Maker of the Last Resort"

This is a new phrase ascribed to central banks during the global

financial meltdown of 2008. During that time, almost all the central
banks, including the US Fed, ECB, PBOC, etc, had pumped in huge
money into their country’s banking system in an effort to avoid
economic recession. This massive effort was dubbed as
‘quantitative easing.’ As a result of buying back of mortgage
securities of inferior quality and other securities, the central banks
have avoided the collapse of their banking system for the time
being. Even Reserve Bank of India massively reduced its policy
rates and reserve ratios and helped stabilizing the Indian markets.
 Rama Krishna Vadlamudi, BOMBAY April 17, 2010
www.scribd.com/vrk100 vrk_100@yahoo.co.in
MY BLOG: www.ramakrishnavadlamudi.blogspot.com

"Borrower of the First Resort"

Reserve Bank of India had continued with its accommodative

policy till the end of January 2010 when it raised the country’s cash
reserve ratio (CRR) by 75 bp to 5.75 per cent. It was followed up
with a 25 basis point hike each in both repo and reverse repo rates
at the end of last month. But despite that, During the first week of
April, banks kept around Rs 1,00,000 crore daily with the RBI and
this has now come down to a daily average of about Rs 50,000
crore – which means RBI is borrowing money from banks for short-
term and it has become a Borrower of First Resort – and what a
transition from lender of last resort to borrower of first resort!

Reserve Bank of India is coming out with its Annual Policy (monetary policy) for the
year 2010-11 on April 20, 2010. Only three weeks back, RBI had given a strong
signal regarding its strong intentions to control inflationary expectations by raising
the repo and reverse repo rates by 25 basis points each to 5 and 3.50 per cent
respectively. In the month of January, it raised CRR (cash reserve ratio) by 75 basis
points to 5.75 per cent. In this background, it is very interesting to predict what
actions RBI will take to keep the economy on even keel balancing between
containing inflation and sustaining reasonable growth. Let us discuss the
expectations from the RBI’s monetary policy for 2010-11.
Till January, RBI continued with its accommodative policy for around 18 months in the
wake of financial turmoil that roiled the markets severely. Despite steep hike in CRR and
withdrawal of other measures, there is still huge liquidity in the banking system.

Reserve Bank of Australia raised its benchmark interest rate by 25 basis points to 4.25
per cent in a meeting early this month. The US had raised its discount rate by 25 basis
points to 0.75 per cent in February this year for the first time in more than a year. China
is also raising its cash requirement ratios regularly since January 2010.

For the month of January of this year, inflation based on wholesale price index (WPI)
was 8.56 per cent. But, in two months it has gone up to almost 10 per cent. This
indeed is a very sharp increase in inflation. Even, food inflation is still around 17 per
cent. How the South-West Monsoon will play out remains to be seen. Fuel prices
were raised at end February. Whether fuel prices will be raised further by the
Government, as world crude oil prices had shot up to USD 87/barrel on the Nymex,
has become a big speculative point in the markets of late. Even though crude prices
have come down to less that USD 83 per barrel, the sharp rise in crude prices is a
matter of concern to the Government in bridging fiscal deficit in the current year.

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 Rama Krishna Vadlamudi, BOMBAY April 17, 2010
www.scribd.com/vrk100 vrk_100@yahoo.co.in
MY BLOG: www.ramakrishnavadlamudi.blogspot.com
FOREIGN FLOWS:
FII INFLOWS (secondary & prim ary) CY 2010

TOTAL
12 000
10 465
10 000

8 000
USD million

EQUITY
5 680 DEBT
6 000 4 785

4 000

2 000

Source: SEBI CY: calendar year

As can be seen from the above table, there is a deluge of foreign money into India
since March 2009. In addition to equity markets (both secondary and primary
markets), debt markets too attracted net inflows of USD 4,785 million or Rs 21,887
crore during this calendar year alone, breaching the overall limit set by the
Government for FII debt flows. Rupee too appreciated sharply of late. This year it
had shown an appreciation of around four per cent against the US dollar. Now,
rupee was quoting at around 44.30 to the dollar at close of Friday.
The above FII figures do not include money received through FDI (foreign direct
investment) route or ECB/FCCBs (external commercial borrowings/foreign currency
convertible bonds). Latest figures from RBI put foreign exchange reserves at Rs
12.43 lakh crore or USD 280 billion. During 2009-10, the reserves went up by 9.4 per
cent in dollar terms, but in rupee terms the appreciation in reserves was less than
two per cent as rupee itself appreciated against dollar by around 12 per cent in
2009-10. The table given below shows the FII net inflows for calendar year 2009.
Both equity and debt markets including, India attracted net inflows of USD 18,507
million or Rs 87,987 crore, as per SEBI.

FII INFLOWS (secondary & prim ary) CY 2009

20 000 18 507
17 457

15 000
USD million

10 000

5 000
1 050

EQUITY DEBT TOTAL

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 Rama Krishna Vadlamudi, BOMBAY April 17, 2010
www.scribd.com/vrk100 vrk_100@yahoo.co.in
MY BLOG: www.ramakrishnavadlamudi.blogspot.com
What are the expectations from RBI’s Annual Policy on
April 20, 2010?
It is estimated by government agencies that India’s GDP would show a growth of
7.2 per cent for 209-10. During the third and second quarters of 2009-10, GDP
grew by 6.0 and 7.9 per cent respectively. For the fourth quarter of 2009-10,
GDP is expected to grow by 8.6 per cent. Industrial production seems to have
gained traction of late as per the IIP figures, prompting the government to raise
excise/CENVAT duties during February. Exports are showing moderate growth
compared to previous year.
The yields of the government securities are hardening. As per latest data, the
benchmark 10-year G-Sec yield has gone up, in the last three months, by around
40 basis points to the present 8.08 per cent; while the 364-day T-bill has
increased by 100 basis points to 5.40 per cent.
The government is expected to borrow 63 per cent of its total borrowing during
the first half of this year. This year will be tough for RBI to manage the huge
government borrowing as it did not have the cushion it had last year in the form
of MSS buyback of securities. The year 2010-11 is going to be a real test for RBI.
Interest rates are on an upward trajectory as inflation is not showing any signs of
relenting with WPI inflation at 9.9 per cent and food inflation at around 17 per
cent. Steel and other manufacturing product prices too are rising. RBI may resort
to some unconventional measures this year, like, issue of more floating rate
bonds, tweaking of HTM category norms, cash management bills, or a cap on
LAF-reverse repo window, or some other measures. During YV Reddy’s regime,
RBI imposed a limit on reverse repo absorption window, which was withdrawn
subsequently. Another measure at RBI’s disposal is hiking SLR ratio.
Huge inflows in the form of portfolio investment, ECB/FCCBs and FDI are going
to be a big challenge. Whether the government would resort to taxing the FII/FDI
inflows (like Tobin Tax or a transaction tax imposed by Brazil recently) remains to
be seen. The imposition of a tax similar to Tobin Tax to curb unbridled growth of
foreign money is strongly advocated by YV Reddy, former governor of RBI.
Taking the rising inflation, huge liquidity in the system, deluge of foreign money,
robust GDP growth, the following policy measures can be expected from RBI:

Raise in repo and reverse repo (LAF) rates by 25 basis points each

Raise in CRR by 50 basis points

In the bond market, the benchmark 10-year yield may go up to 8.50 per cent
gradually; while the stock market may react negatively and the indices,
especially, banking, auto & realty indices, may drift down in the next one month.
Design and tables: Author Disclaimer: The views are personal

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