Eastern Financiers Ltd RBI Monetary Policy—Mid Quarter FY2011-12 16th Mar 2012 Amazingly surprise cut in Cash Reserve ratio before the policy date and the erratic surge in the Industrial Growth before the policy announcement that anticipated the policy to be a non event landed on expected lines with no cut in the repo rate. RBI curtailed the CRR by an astounding 75BP a week ahead of the policy to 4.75% that was effective 10th March and infused about Rs. 48000 crores of liquidity in the economy. This measure was necessitated ahead of this scheduled Mid-Quarter Review to address the persistent structural liquidity deficit beyond the Reserve Bank’s comfort level, which would have further worsened during the week of March 12-16 due to advance tax outflows. This was the second cut in the CRR this calendar after the 50BP slash in the January policy which injected Rs. 32000 crores in the economy. In all, total liquidity of Rs. 80000 crore has been infused by way of CRR cut since the beginning of the calendar. RBI kept the repo rate under the liquidity adjustment facility unchanged at 8.5%. Repo rate—the rate at which banks borrow from RBI has not been chopped since the last two years—it is however the period during which it clambered from 3.5% to 8.5% under restrained economic scenario. Consequently, the Reverse repo under the liquidity adjustment facility and the marginal standing facility parks at 7.5% and 9.5% respectively. The bank rate remains unchanged at 9.5%. In addition to the apprehensions over inflation, RBI’s perspective has now expanded to the burgeoning fiscal deficit, surge in the crude oil prices and the depreciating INR that would lead the current account deficit to inflate further. Inflation though has evolved along the projected lines but the recent surge in crude oil and weakening of the Indian currency has aroused upside trepidations to inflation. RBI says that there continues to be significant suppressed inflation in fuel, fertilizer, and power since it feels that much of the rise in the prices of these commodities is not passed onto the consumer and this non reflection on administered prices is worrying.

Policy Rates 8.5 8.5

Repo Rate 8

8.5 8.5 8.00

8.25

7.50 7.00

7.5 7.25 6.5

5

5.25

6 5.75 5.5

REVERSE-REPO

6.50 6.00

6.75

5.50

6.25

5.00 4.50 4.00 3.50 3.00

RBI Governor Mr. Subbarao who harped on credible fiscal consolidation in the March credit policy emphasized once again on keeping inflationary risks in check and growth seemed to have taken a back seat. Despite of wide betting on rate cut after the Budget, RBI’s statement reflects a post-Budget rate cut less of a certainty. The statement says: “Recent growth-inflation dynamics have prompted the Reserve Bank to indicate that no further tightening is required and that future actions will be towards lowering the rates. However, notwithstanding the deceleration in growth, inflation risks remain, which will influence both the timing and magnitude of future rate actions.”

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Eastern Financiers Ltd RBI Monetary Policy—Mid Quarter FY2011-12 16th Mar 2012 Monetary Measures The repo rate under the liquidity adjustment facility (LAF) has been kept unchanged at 8.5%. As per the new operating procedure, the reverse repo rate under the LAF, determined with a 100 basis point spread below the repo rate, will stand adjusted at 7.5%. The Marginal Standing Facility (MSF) rate, determined with a spread of 100 basis points above the repo rate, gets calibrated at 9.5%. The Bank Rate remains unchanged at 9.5%. The cash reserve ratio (CRR) that has been curtailed before the policy by 75BP stands adjusted to 4.75%.

Indian Economic Outlook Inflation

Moderating WPI (%)

After remaining above 9% during AprilNovember 2011, y-o-y headline WPI inflation rate 9.72 9.44 9.419.35 9.22 moderated to 7.7% in December and further to 9.11 9.06 6.6% in January 2012, before rising to 6.95% in February. The moderation was mainly aided by a 8.31 mellowing down trend in the primary food articles. Fuel and manufactured products groups also contributed to the cause. Primary food 7.47 6.95 articles inflation, which stood at a mere 0.8% in December, entered the negative zone (-0.5%) in January 2012, before rising to 6.1% in February. 6.55 Although the numbers have trickled in way below the 9% levels witnessed earlier during the fiscal, the erratic movement in the primary food articles inflation gives little comfort in terms of understanding its future trajectory. On the other hand, negating the steady north-bound journey of the global crude prices, fuel group inflation moderated from 15% in December to 12.8% in February, reflecting the absence of commensurate pass-through to domestic consumers. Non-food manufactured products inflation too down-sized partially from 7.9% in December to 5.8% in February 2012 accounting for both a slowdown in domestic demand following the monetary tightening and moderation in global non-oil commodity prices. The momentum indicator of non-food manufactured products inflation (seasonally adjusted 3-month moving average inflation rate) also showed a moderating trend. Interestingly, Consumer Price Index (CPI) inflation (as measured by the new series, base year 2010) for the month of January 2012 was 7.7% reflecting the fact that price pressures persist at the retail level. Inflationary pressure, although has eased to a considerable extent, owing to a stern fight-back by the central bank in the form of steep tightening in the key policy rates, there still remains considerable up-side risks owing to the recent up-surge in the Crude-Oil prices that is yet to get passed on to the retail level. Also the volatility in the currency market, given the uncertain global scenario could rub salt in the wound. 9.689.74

9.78

9.73

Growth Tight Monetary Policy has had its effect on the growth of the domestic economy as the slowdown precipitated further, as indicated by the third quarter GDP number that shredded down to 6.1% from 6.9% in Q2 as the industrial segment witnessed a tough time owing to weaker demand, higher cost of capital and a host of other regulatory and systematic hurdles. During the quarter ending December 31, growth in the manufacturing sector dipped to a meager 0.4% from 7.8% in the corresponding period of 2010-11. Farm output also exhibited a similar trend and expanded by just 2.7% during the quarter, compared to 11% in the corresponding period last fiscal. The Central Statistics Office has estimated the full year growth for 2011-12 at 6.9%, which is in line with the Central Bank’s projection. Deceleration in investment activity and weak external demand played spoil sport.

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Eastern Financiers Ltd RBI Monetary Policy—Mid Quarter FY2011-12 16th Mar 2012 Growth in industrial production, as reflected by the index of industrial production moderated to 4% during 2011-12 (AprilJanuary) from 8.3% in the corresponding period a year ago. While growth in the capital goods & intermediate goods sectors were negative, growth in the basic goods and consumer goods sectors decelerated marginally. Although the IIP numbers have clearly indicated demand erosion, the volatility in the IIP numbers has made it an increasingly unfaithful gauge of the industrial growth. To the contrary of the IIP numbers, the manufacturing PMI had a different story to tell. India's manufacturing activity remained robust in February and stayed close to its eight-months peak. The seasonally adjusted HSBC Purchasing Managers' Index (PMI) posted a reading of 56.6 in February, fractionally lower from January's 57.5, the highest of the past eight months. A reading of 50 separates growth from contraction. Strong growth in the new orders sub-index, which rose to 62.8 in February and factory output drove the expansion in the sector. Although corporate sales continued to mount up, margins got compromised indicating the increasing difficulty to pass on the hike in input costs. All the macro indicators suggest that the growth in the domestic economy is definitely slowing down and both global and local headwinds coupled with choking liquidity in the system has taken its toll on the growth dynamics of the economy, so far. However, with easing liquidity conditions, courtesy CRR cuts, and a slight improvement in demand situation could translate into a slightly better performance in Q4 against that exhibited in the third quarter ending December-2011.

Dwindling Growth (%)

Erratic IIP 6.60

8.9

6.82 5.90

3.70

8.9

3.60

8.2

3.30

4.10 2.00

1.60

7.7

1.82

6.9

6.1

Jan-12

Dec-11

Nov-11

Oct-11

Sep-11

Aug-11

Jul-11

Jun-11

May-11

Apr-11

Mar-11

(5.10)

Feb-11

7.8

Jan-11

9.4

8.80

7.30

Dec-10

10 9.5 9 8.5 8 7.5 7 6.5 6 5.5

Global Outlook On the global façade RBI’s statement manifested optimistic driven by improved data on the US economy that included labor market conditions and employment among others. Global macroeconomic situation seemed to have perked up since third quarter review of the RBI. However, as per the US Federal Reserve the economic conditions warrant exceptionally low levels for federal funds rate at least through late 2014. The immediate financial market pressures in the euro area have been alleviated to some extent by the ECB injecting liquidity of more than one trillion euro through the two long-term refinancing operations. However, growth in the euro area turned negative in the fourth quarter. The emerging and developing economies (EDEs) are showing signs of growth slowdown. As a result, the global growth for 2012 and 2013 is expected to be lower than earlier anticipated. Inflation pressures in both advanced economies and EDEs moderated towards the end of 2011 on account of subdued domestic demand and correction in non-fuel commodity prices. Global crude prices, however, have spiked suddenly reflecting both geo-political concerns and abundant global liquidity, accentuating the risks to growth and inflation.

Stance Subbarao’s policy signalled that RBI is still not comfortable on the inflation front despite slipping growth and would rather take any action once inflation risks were lower and steps towards “credible” fiscal consolidation were visible in the Budget. RBI governor Duvvuri Subbarao did nothing on rate cut and opted to take a cautious approach and maintained status quo on rates. Close reading of the fine print reflects that the RBI Governor will be one of the most careful observers of what finance minister Mr. Pranab Mukherjee delivers in the much awaited Union Budget on 16th March after the Railway Budget on 14th March.

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Eastern Financiers Ltd RBI Monetary Policy—Mid Quarter FY2011-12 16th Mar 2012

EASTERN FINANCIERS RESEARCH DESK Rajesh Agarwal – Head of Research

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[email protected]

Nandita Jaiswal- Sr. Research Analyst

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Biswarup Chakraborty- Research Analyst

033 – 4011 7800 [email protected]

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