Thursday, March 22, 2012

Monetary and Credit Policy: Repo and Reverse Repo Rates Unchanged

The Reserve Bank of India (RBI) has recently released its mid-quarterly review. It has clearly spelt out that monetary policy actions will be in terms of rate cuts going forward, given the moderating growth momentum and higher downside risks to growth.
The RBI kept repo and reverse repo rates unchanged at 8.5 per cent and 7.5 per cent, respectively, to fight rising inflation in Asia's third largest economy. The central bank left Cash Reserve Ratio (CRR–(money that banks must keep with the RBI) unchanged at 4.75 per cent. Recently, the RBI slashed CRR, the portion of deposits banks are required to keep with the central bank, by 0.75 percentage points, a step that was meant to infuse Rs 48,000 crore into the economy.
Earlier on March 9, the central bank cut CRR by a hefty 75 basis points, or three-fourths of one per cent, from 5.5 per cent to 4.75 per cent effective the fortnight beginning March 10.
The markets and the corporate sector were expecting the CRR cut on March 15 when the RBI is scheduled to announce its mid-quarter review. But the central bank said on Friday it feared a liquidity crunch due to the advance tax (to be paid before March 15) outflows; and this would have increased the already tight position of banks due to the usual frontloading of cash balances with the RBI.This CRR cut will inject around Rs. 48,000 crores of primary liquidity into the banking system. Earlier in January, the cut in CRR of half a per cent injected Rs. 31,500 crores into the banking system. The CRR cut was welcomed by banks and the corporate sector.
On January 24, RBI had cut CRR by 0.5 percentage points to 5.5 per cent, releasing Rs 32,000 crore into the system. Since then, the fund crunch has only worsened.
The strain on the system rose to high of Rs 1.02 lakh crore. And going forward it will only increase as by March 15 companies will have to make advance tax payments which will drive out Rs 60,000 crore from the system.
Another Rs 12,000 crore is likely to go out of banks due to the Oil and Natural Gas Corporation (ONGC) auction last week, and a similar amount will be drained out on account of excise duty payment by companies.
Rate of Inflation
Inflation rose to 6.95 per cent in February which is much above the Reserve Bank’s comfort level of 5-6 per cent. RBIs own forecasts of inflation is that it will go down to 7 per cent levels in March 2012 from November 2010 levels of 9.11 per cent. RBI has indicated that non food manufacturing inflation is still a worry as it has gone up from 7.6 per cent in October 2011 to 7.9 per cent in November 2011. However, it has reiterated that despite the rise in non food manufacturing index, headline inflation momentum is slowing down.
The market will now have to work out its own math on inflation. Inflation can surprise on the downside as much as it has surprised on the upside. It is going to be a difficult call on where inflation is headed in 2012, but considering the fact that prices are already at elevated levels with inflation as measured by the Wholesale Price Index (WPI) averaging over 9 per cent for the past two calendar years, inflation has the ability to come off sharply especially if global growth slows down dramatically.
GDP Growth
There are now serious concerns on the slowdown in the Indian economy as the Gross Domestic Product (GDP) growth figures for the September-December 2011 quarter came in a paltry 6.1 per cent, the lowest since the Lehman crisis that shook the global economy in 2009.
The economy has given mixed signals in the past few months with some green shoots being seen on inflation, foreign institutional investor inflows, stock markets, the rupee and policy action picking up.
However, the figures come as a dampener as they are well below estimates. It is clear the lag effect of problems seen last year of low investor confidence resulting in low investment, high inflation and high interest rates and policy inaction are playing out. The surprise is that GDP growth is now at the level seen during the Lehman crisis when the world economy was in a reset mode though the situation has improved since.
GDP growth decelerated to a low of 6.1 per cent in the third quarter of fiscal 2012, raising fresh concerns about the growth slowdown. Industrial sector continues to be the main laggard and grew at an anemic rate of 2.6 per cent due to falling domestic demand and faltering global recovery.
The magnitude of moderation has been a bit of surprise because advance estimates released earlier had pegged financial year 2012-13 growth at 6.9 per cent.
According to FICCI, it would be ironical if GDP growth in 2011-2012 goes below 6.8 per cent, would be lower than in the crisis that was achieved in 2008-09 — the year of the post Lehman crisis.
Foreign Trade
Indian imports continued to outpace exports in February as demand remained weak in major exports markets like the United States and Europe, nudging the government to revise up the full-year trade deficit projections.
A widening trade deficit will likely worsen India's current account deficit and further weaken the rupee. Merchandise exports grew an annual 4.3% to $24.6 billion in February, while imports grew 20.6 percent to $39.8 billion.
The trade deficit widened to $15.2 billion during the month, from $14.8 billion in January.

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