Mid-Quarter Monetary Policy Review

Monday | June 17, 2013

Content
RBI silent on interest rates Challenge for the Indian Economy Indian Economic Scenario World Currency Markets

Reena Rohit Chief Manager Non-Agri Commodities and Currencies reena.rohit@angelbroking.com (022) 3935 8134

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Mid-Quarter Monetary Policy Review
Monday | June 17, 2013

Reserve Bank of India – Silent on Interest Rates
Repo Rate 7.25% Citing growth-inflation dynamics and recent developments in the external sector, the Reserve Bank of India (RBI) kept interest rates unchanged as Reverse Repo Rate 6.25 % expected. Indications for further changes in interest rates in the July’13 Cash Reserve Ratio 4% policy are currently mute but may change over time, given that the monsoon this year is expected to be normal, thus reducing the supply-side Bank Rate 8.25% pressure and thereby easing inflation. This scenario would lead to the RBI reducing rates in order to boost growth. In the current policy, the central bank faced pressure from two sides i.e. either to boost growth by lowering interest rates or tackle inflation, which is an existing issue especially due to the weaker Rupee, which is leading to increase in costs of commodity imports.

Fall in the WPI to 4.7 percent has not been a strong enough factor for the central bank to reduce interest rates as food inflation remains high. While factors like distribution and supply of food are affecting food inflation, measures to tackle the same need to be introduced. A good monsoon progress on a pan-India scale ahead of time will help to bring down food inflation in the coming months. Developments on the external sector front, being one of the major factors that drove the RBI’s decision, need to be looked at closely. Sharp depreciation in the Rupee along with a widening of the trade deficit due to a surge in gold imports has restricted interest rate cuts by the RBI. In its review, the central bank has indicated that the key to boosting economic growth could be done through increasing investment by creating a favorable and conducive environment for private investment, improving project clearance and raising the role of public investment. This move by the RBI has largely dampened sentiments at a time when the world economy is suddenly witnessing a slowdown in growth momentum. Recent measures in order to reduce the Current Account Deficit (CAD) by way of curbing gold imports through restricting its supply and increasing customs duty, it looks like the RBI is using indirect measures to reduce economic hurdles and is also applying the same strategy to boost economic growth.
Repo Rate (%)
10.2 9.2 8.2 7.2 6.2
8 7.5

Reverse Repo Rate (%)
7.5 6.5

9 8.5 7 6.5 6.75 8.5

7
6.5 6 5.5

6 5.5

6 5.25

6.25

7.25

5 4.5 4 3.5 3

6
5.2 4.2

4.5 3.25
27-04-2001 28-05-2001 23-10-2001 28-03-2002 30-10-2002 3-03-2003 19-03-2003 25-08-2003 27-10-2004 26-10-2005 8-06-2006 31-10-2006 31-03-2007 25-06-2008 20-10-2008 8-12-2008 5-03-2009 19-03-2010 2-07-2010 16-09-2010 25-01-2011 3-05-2011 26-07-2011 25-10-2011 17-04-2012 19-03-2013 17-06-2013

4.75
27-04-2001 28-05-2001 23-10-2001 28-03-2002 30-10-2002 3-03-2003 19-03-2003 25-08-2003 27-10-2004 26-10-2005 8-06-2006 31-10-2006 31-03-2007 25-06-2008 20-10-2008 8-12-2008 5-03-2009 19-03-2010 2-07-2010 16-09-2010 25-01-2011 3-05-2011 26-07-2011 25-10-2011 17-04-2012 19-03-2013 17-06-2013

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In each of its policy reviews in the past, the RBI had cut interest rates to boost growth.

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Mid-Quarter Monetary Policy Review
Monday | June 17, 2013

Challenge for the Indian economy – Sustain capital inflows and increase investments
Since the onset of the global financial crisis, world markets have placed great emphasis on the monetary policy developments in the major economies. From the Asian market context, India is one of the major economies and the monetary policy decisions by the Reserve Bank of India (RBI) would most likely impact investment decisions globally. By keeping interest rates steady, the role of the central bank becomes even more challenging given the current weak domestic economic scenario. The weakness in the Rupee has already raised a host of economic problems - from raising the import bill, as major commodities are imported to making the CAD rise, which has touched elevated levels. Also, with the US economy on a growth trajectory, there are large expectations that investment flows into India could be affected. Although at a slow pace, the US is witnessing a rise in economic activity as opposed to previous years and that its job market is also reviving. With improving US economic data and expectations of the monetary stimulus pullback, the Indian economy will have to gear up in order to sustain capital inflows and increase the concentration of investments in India in order to mitigate the impact of a bounce back in the US. This is because, better economic prospects and treasury yields in the US will reduce investor concentration and participation in the Indian markets. Asia, in any case is seeing a marked slowdown, with China being at the forefront.

Net Investments vs. Rupee Movement (Monthly Avg)
57 56 55 54 53 52 51 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 -5,000 -10,000

50
49

Net Investments (Rs. Cr)
Source: RBI, Reuters, Angel Research

Rupee -Monthly Average

March’13 has witnessed a slowdown in capital inflows, which is now a major concern to the Indian economy at large. Sharp appreciation in the Rupee was seen during Jan’12 and Feb’12, however only for a short period as a decline in investment flows led to depreciation in the currency. We could expect a repeat of a similar pattern if measures are not taken ahead of time. But a positive factor in this context is that the Federal Reserve’s withdrawal of stimulus measures is not expected to happen immediately, thereby buying time for the Indian economy to boost growth by implementation of aggressive measures.

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Mid-Quarter Monetary Policy Review
Monday | June 17, 2013

Indian Economic Scenario

Indian Quarterly GDP Growth (%)
12 11 10 9 8 7 6 5

11.2 9.6 9.8 9.8
9.2

5.1 3.5
10/1/2005 10/1/2006 10/1/2007 10/1/2008 10/1/2010 10/1/2012
10/1/2009 10/1/2011

4
3

4.8
6/1/2012 2/1/2013

6/1/2005

2/1/2006

6/1/2006

2/1/2007

6/1/2007

2/1/2008

6/1/2008

2/1/2009

6/1/2009

2/1/2010

6/1/2011

Source: RBI, Reuters, Angel Research

Indian Economic growth has been on a declining trajectory from 2010 onwards. From a quarterly GDP of 11.2 percent in Q4FY2009-10 to growth of 4.8 percent in the Q4FY2012-13, deceleration in growth has had a major impact on the domestic currency market. Negative cues from the overall slowdown in the global economy also impacted India. Further growth will now be dependent on the course the world economic growth takes.

2011 Onwards Rupee has Weakened Sharply
12 11 10 9 8 52 50 48 46 44 56 54

7
6 5 4

Quarterly GDP (% Chg)
Source: RBI, Reuters, Angel Research

Average Rupee Value

The adjacent chart suggests that movement in the Rupee is strongly correlated with growth in the economy. Average value of the Rupee has moved according to the rise or fall in the economy. The Rupee depreciated considerably as GDP slipped from 11.2 percent in Q4FY2009 and continued its journey downwards. Between Q3FY2009-10 to Q2FY2011-12, average value of the Rupee stood between 44-45. Thereafter, it has traded above 50 levels and breached the 54-mark Q2FY2012-13 onwards.

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2/1/2012

6/1/2010

2/1/2011

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Mid-Quarter Monetary Policy Review
Monday | June 17, 2013

World Currency Markets
Apart from the expectations of Federal Reserve’s actions, it is the movement and the volatility in the Japanese Yen that is playing a major role in the world currency markets currently. Extreme and aggressive stimulus and boosting measures by the Bank of Japan have provided a quick boost to the Japanese markets. However, we feel that this rush of aggressive measures amid high fiscal strain would not be fruitful over the long run. Coming to the US, expectations with respect to the pullback in Federal Reserve’s bond-buying program have been factored in and markets are not anticipating an immediate withdrawal. Hence, in the next few months at least, the Fed’s monthly bond purchases are expected to continue, thereby keeping a check on the rise in the Dollar Index. This in turn would act as a positive factor for the Rupee, which has depreciated sharply over the year. The impact of RBI’s policy review today is expected to be muted and further cues will be taken from the Federal Reserve’s monetary policy review which is scheduled for 18th – 19th June’13. We feel that the Federal Reserve would also buy time to judge the overall US economic scenario and slate this pullback over a long-term period. But statements by the Federal Reserve Chairman Ben Bernanke will provide further direction to the world equity and currency markets, and also to the Rupee.

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