RBI panel for one policy rate to tame inflation

A Reserve Bank of India (RBI) working group today suggested that the short-term lending rate (repo) be made the single policy rate to signal the monetary policy stance, to effectively deal with inflation without hurting growth. At present, there are
three rates -- repo, reverse repo and bank rate -- through which RBI injects or
absorbs liquidity from the system.  The proposal is aimed at aligning the Indian monetary system with international best practices. The RBI has invited comments from the stakeholders till March-end on the proposal.  "The repo rate should be
the single policy rate to unambiguously signal the stance of monetary policy to
achieve macroeconomic objectives of growth with price stability," the RBI
working group said.  Under the proposed system, reverse repo and bank rate would adjust automatically with change in the repo rate, which would be announced by the RBI with a view to tame inflation and promote growth.  All the rates will operate within a corridor of 150 basis points, said the working group which was headed by RBI Executive Director Deepak Mohanty.  While the bank rate would be 50 basis points above the single policy rate (repo rate), reverse repo rate would be 100 basis points below it, the report said.  The panel further said that bank rate, which has remained dormant since April 2003, should be re-activitated as a monetary management instrument.  "The bank rate be activated as a discount rate with a spread over the repo rate. Once the policy rate changes, the bank rate should change automatically with a fixed spread over the repo rate," it added.  Bank rate is the rate at which banks can borrow long-term funds from the RBI to overcome
liquidity shortage. Banks, however, have been borrowing mainly from repo
window, which is a short-term instrument.  Currently, the repo rate is 6.5%, reverse repo (short-term borrowing) rate 5.5% and bank rate 6%. Although the RBI has raised key policy rates seven times since March 2010 to tame inflation, it has kept the bank rate unchanged since April 2003.

FinMin, RBI officials to decide on Apr-Sep borrowing by Mar 25

The Ministry of Finance and Reserve Bank of India (RBI) officials would decide on the borrowing calendar for April-September on March 25, a senior finance ministry official said on Tuesday. Finance Minister Pranab Mukherjee, in his post-Budget interaction on February 28, had said the government would conduct borrowing for the coming financial year in a non-disruptive manner, leaving enough space for the private sector’s investment needs.  Government borrowing is typically frontloaded, with 60-65 per cent of the plan completed in the first half of the financial year itself, as tax proceeds are poor in this period.  The government’s gross borrowing for 2011-12 has been pegged at Rs 4.17 lakh crore, as against Rs 4.47 lakh crore this financial year. The net borrowing is pegged at Rs 3.43 lakh crore, as against Rs 3.35 lakh crore for 2010-11. About the borrowing plan for this year, the official said the government was unlikely to borrow the last tranche of Rs 10,000 crore due this month.  “We will allow it to lapse as we are comfortably placed,” the official said. In that case, this year’s borrowing will settle at Rs 4.37 lakh crore on a gross level and Rs 3.25 lakh crore on a net basis.

Malegam views on MFIs leave banks uneasy

The Malegam Committee’s report on microfinance institutions (MFIs) was being seen as bringing relief to low-income borrowers. However, it has made banks apprehensive about the proposed framework. The functioning of MFIs might be affected if the stringent norms suggested by the committee were implemented, bankers said.  Set up by the Reserve Bank of India (RBI) to look into the issues concerning the MFI industry, the committee had suggested caps on interest rates and margins. While it suggested an average margin cap of 10 per cent for MFIs with a loan portfolio of Rs 100 crore, a cap of 12 per cent was recommended for smaller players. Also, it suggested capping the interest on individual loans at 24 per cent. MFIs are allowed to levy only three charges — processing fee, interest,
and insurance charge. The committee also suggested that loans extended to a
single borrower be capped at Rs 25,000.  According to bankers, MFIs — especially the smaller ones — will come under pressure in terms of profitability if the committee’s suggestions are made mandatory. On March 17, leading bankers will meet the RBI brass and give their feedback.  MFIs raise 75-80 per cent of their funds via bank borrowings, 15 per cent from equity and 10 per cent from sources like cash securities. As of now, interest rates charged by them hover around 18-32 per cent, bankers say. Bank finance to MFIs is categorised as priority-sector
lending.  To hedge risks, MFIs have been asked to replace weak collateral with better-quality assets, as banks are worried about the deteriorating quality of the loan portfolio of some MFIs, particularly those operating in Andhra Pradesh. Banks are seeking booked business (loans to borrowers) as primary security before approving a fresh line of credit to MFIs.  Following the events in Andhra Pradesh (political controversy on lending practices, new rules to curb functioning), since October, standard loans have been converted into non-performing assets for banks, leading to a sharp dip in the repayments from MFI borrowers.  The main critics of the Malegam committee report are of the opinion that smaller MFIs will cease to exist since the report favours capping margins and interest rates. However, the committee
argued that consolidation was necessary as too many smaller MFIs might put the
banking system at risk, since two-thirds of their funding requirements are met
by banks.  “The main reason we need an optimum size is that costs fall when you achieve a certain size. Thus, you can afford offering a lower interest rate. Also, 75 per cent of MFI funding is through the banking system. So, if all MFIs remain small, the risk to the banking system would become very large. If this leads to some consolidation, that is unavoidable,” Y H Malegam had said.

Financial inclusion has the potential to add to banking income

Mumbai: Financial inclusion is still not profitable but over a time it has the potential to add to banking income, provided lenders collaborate with technology providers and offer more products to customers, bankers said at the Mint Annual Banking Conclave in Mumbai on Tuesday.  Neeraj Swaroop, regional chief executive officer, India and South Asia, Standard Chartered Bank, said a large number of accounts the bank has opened as part of financial inclusion remain unused. Financial inclusion does not work if there is no access to basic needs like food, he said. “Only partnership, collaboration and technology will drive our plans,” Swaroop said.  O. P. Bhatt, chairman of the State Bank of India, the largest bank in the country, said banks will have to look for alternative channels.  “We have already reached 1,25,000 under banked villages through point of sale terminals, kiosks and more than 100 partners. Now we have signed an MoU with Airtel to use their 1.5 million outlets,” he said.  “Airtel has people in those outlets and they can handle cash and we have banking services. The application is pending with the RBI (Reserve Bank of India) and if they give us a go-ahead, we can roll it out by 31 March. We need partnerships of all types to succeed,” Bhatt said.  Chanda Kochhar, managing director and chief executive officer at ICICI Bank Ltd, said the bank is focusing on ensuring a “comprehensive model” and using “every bit of technology.”  “We have to improve revenues by selling more products to the same customer and cut costs by using technology. We have already reached 1 million customers and are progressing well. But you cannot roll out all six products at one go,” she said.

Indian banks will need to tap overseas markets for capital

Mumbai: Indian banks will have to tap global markets to face the challenge of rising capital requirements, besides managing liquidity effectively to meet long-term funding
requirements, Reserve Bank of India (RBI) Deputy Governor K.C. Chakrabarty said
on Tuesday.  “Not only the increased capital, the cost of capital is also going to increase. How banks are going face is this is a challenge,” Chakrabarty said at the Mint Annual Banking Conclave in Mumbai on Tuesday.  Chakrabarty also stressed that management of liquidity is set to become a key issue for banks to finance long-term funding requirements.  “Banks usually borrow at very short and lend long-term. Banks have to raise different type of long-term resources to meet the liquidity requirement. More funds have to be raised by the banks,” Chakrabarty said.  RBI is currently in the process of formulating guidelines on anti-money laundering that will deal with issues like tax avoidance and cross-border capital flows, he said.  Noting that central banks globally are facing various challenges in the current uncertain global environment to safeguard their respective economies, Chakrabarty said apex banks can operate more effectively when insulated from external interference.  Also, in the face of increasing interference among global financial financial markets, banks are more “susceptible” to development in financial markets, Chakrabarty said.  It is not possible to achieve financial stability without achieving financial inclusion or giving access to the poor to basic banking services, Chakrabarty said, adding that banks have to utilize technology in a cost-effective way to achieve this goal.  “Using technology for reducing the cost of transactions and improve reporting standards is going to another challenge for banks,” Chakrabarty said.  Further, the
implementation of International Financial Reporting Standards or IFRS is also crucial for the Indian banking system in view of the increasing integration of global markets, Chakrabarty said.

Auction, publicise govt cash balances, says Mohanty report

The high government cash balance, which  has often created uncertainty in liquidity conditions, could now be auctioned  to reduce cash volatility, says the Deepak Mohanty committee set up by the Reserve Bank of India to study the operating procedure of monetary policy.  According to the report, a major source of
uncertainty in liquidity was the sudden rise in government cash balances. To
manage the liquidity arising out of this, the report said RBI did not have any
corresponding instrument.  The issue of auctioning of government cash balances is under consideration of the government and RBI, said the report. “If this happens,
huge cash balances with the government will not create a liquidity crunch.
Government will be able to auction the money temporarily and, hence, will not
be forced to spend to maintain liquidity in the system,” said a treasury
official with a public sector bank.  To help market participants make a better calculation of liquidity in the system, the group suggested the data on government cash balances be made public daily, with a minimum time lag. “As government cash balances have been a major source of uncertainty in liquidity, the dissemination of this information will help improve the assessment by market participants,” said the report. “We will be able to understand the temporary gap in the system, thereby easing pressure on short-term interest rates,” said the treasury official.  The existing liquidity forecasting model needs to be re-examined and the weekly forecasting model should be improved, the working group also said.  “The
predictive power of the model has not been satisfactory for the system in a
deficit mode,” said the report. Currently, RBI’s liquidity forecast is made
weekly, for up to four weeks ahead.  If these recommendations are accepted by the RBI, the data will be a part of the Money Market Operations released daily and also be published in the Weekly Statistical Supplement of the RBI Bulletin. At present, the RBI publishes the information on banks’ cash balances with itself after a lag of three days.

Prepaid travel card

It allows conversion of foreign currency notes or travellers’ cheques into Indian currency and is then loaded onto the card. 


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Q&A: K C Chakrabarty, Deputy Governor of RBI

At a time when banks are facing a situation of rising interest
rates threatening loan growth, managing the growth-inflation dynamics has
became one of the main challenges of the Reserve Bank of India (RBI). K C Chakrabarty, Deputy Governor of RBI, speaks to Manojit Saha on this and a host of other issues. Edited
excerpts:

Banks are saying high interest rates are  hurting credit growth. How will RBI balance the growth-inflation trade-off?

If the inflation is high, interest rates will remain high. That is  why RBI insists on having low inflation so that interest rates can be low. All  efforts are to be diverted in that direction. You cannot have a situation where  inflation is high and interest rates are low.

RBI had expressed concern on the practice of lending money that was
borrowed from RBI under the liquidity adjustment facility (LAF). But banks say,
since the funds borrowed from LAF are against government securities, that is
not a problem.

Why don’t banks liquidate the security and lend that money? The LAF money is not meant for lending purpose on a continuous basis. The system cannot run like that. The LAF facility is for meeting liquidity needs arising out of mismatches of temporary nature.

New players are set to enter the banking system. What modifications RBI expects in the Banking Regulation Act to have more power?

I am not fully aware of the developments.  However, one aspect which stands out very clearly is the fact that orderly conduct of financial market with wider participation presupposes the ability of regulator to change the management and
board of the institution when they are not functioning within the regulatory and contractual framework. Legal provisions must support that stand.

The Malegam Committee has proposed RBI to be the regulator of microfinance institutions. How will you ensure that MFIs treat their customers fairly?

Any business entity, if you consider MFI as business entity, must treat its customers fairly and properly for the benefit of the company. So MFIs must treat their customers fairly for their own survival.  Until now, RBI was not regulating the MFIs, or you can say, it was a soft touch regulation. We have come to the conclusion that at this stage of development, MFIs are relevant but they need to be regulated more stringently. But one should appreciate the fact that the entire cross-section of the society also wanted the same.

Will the central bank ask all MFIs to register with RBI?

If there is somebody left out of the regulatory framework then we have to see whether it is creating a regulatory arbitrage or not and how do we tackle them.

Some recent developments, like the loan-for-bribe scam or the fraud that happened at a branch of a foreign bank, point to lack of proper risk management practices in banks. Do you think that banks have to re-look at the risk management practices?

Absolutely, no doubt about that. We are at a very nascent stage of risk management. It has to mature, it has to perfect itself and we must understand that as and when business becomes more complex and global, the need for better and sophisticated risk management will arise. This is one area where we cannot be complacent, neither the banks, nor the regulator.

Can you highlight any specific areas in risk management which need to be looked at?

First, we have to understand the risk philosophy. Risk management is not to avoid the risk. It is about how much risk we should take for a given profit, while keeping the system stable. That understanding has to come. We have to understand, wherever return is higher, risk is much higher. Banks should measure the risk and price it appropriately.

At present, there are no norms on relationship managers who offer portfolio management services in banks. Will the regulator consider norms for such activities?

Banks which are in that business must have proper norms for identifying the people for this job.

What we are saying is that banks should have a proper risk management framework which is approved by the board. Banks must understand the risks of the business and also have the responsibility of making customers aware of the same.

Many of these wealth management products are in the purview of various regulatory agencies. That is why a combined approach is necessary. But the cardinal principle, that don’t sell the product to people who don’t understand the product and the risks associated with it, stands.

The stance of RBI was not to prescribe or cap interest rate or charges of banks. It was left to the market forces. But there seems to a departure from that practice. What has prompted this shift in stance?

We have not capped any charges as yet, it is pre-mature. However, we must understand any market functions based on the availability of information. If there is an asymmetry of information, no market can function efficiently. Now-a-days, we observe that there is too much of asymmetry of information between the provider of the services and the one who is availing the services. In any regulated activity, the issue of protecting the interest of the consumer is paramount. Hence, this type of thinking crops up. This is relevant not only in India, but this trend is also felt across the globe. Those who fail to read this trend will be left behind. When the competition is not able to take care of the price, regulatory process has to intervene to protect the most vulnerable section of the society.

Why is RBI repeatedly saying banks must cut interest margins. Interest margin is the very key operating and profitability variable. Almost all the banks are listed entities. Isn’t this direction misplaced from a minority shareholder perspective?

What we are saying is that technology should bring down the operating costs of banks significantly. It has happened in various sectors like telecommunications, aviation etc. We are urging the banks to bring down the costs of operation and pass on the benefit to both depositors and borrowers without sacrificing return on asset and return on equity.

Banks have started implementing the financial inclusion plan during the financial year. How has been the progress so far? Is the regulator happy with the banks’ efforts?

Banks have started and they have a long way to go. It is a difficult journey. Banks are trying, they need to try harder and every segment of the society needs to support them then only financial inclusion will become a reality.  Delivery model for financial inclusion is still a problem. We are yet to evolve a cost effective delivery model.

The current phase of economic growth is largely driven by infrastructure. However, banks are having asset liability mismatch problems from infrastructure lending and some of the banks have also reached sectoral caps. What can RBI do to strengthen bank’s infrastructure financing capabilities?
Infrastructure financing requirements are huge and only banks will not be able to finance those. Other types of institutions are also necessary. All relaxations, whatever demanded and what is necessary, feasible and prudent have been given to the banks to ensure that funding to infrastructure does not suffer.

Too early to assess impact of Japanese disaster on India: RBI

The Reserve Bank on Tuesday said it is "too early" to assess the financial impact of the Japanese disaster on India and it is in constant touch with Bank of Japan (BoJ). "It is too early to make an assessment of the financial impact of the
Japanese disaster (on India)," Reserve Bank of India Deputy Governor K C Chakrabarty said. He further said RBI is in regular touch with the Bank of Japan. He further added that "they (BoJ) tell us that the financial markets will
stabilize in the next few days".

'Banks taking longer to clear MFI loan applications'

Witnessing slowdown in business, the microfinance industry has said banks were shying away from advancing loans to them.  “Bank lending for fresh loans has
been very selective. The entire process of considering loan applications from
microfinance institutions (MFIs) is moving very slowly,” Alok Prasad, chief
executive, Microfinance Institutions Network (MFIN), said.  In January, the
Reserve Bank of India (RBI) had relaxed the debt restructuring norms for MFIs
to enable banks to provide them liquidity support. These norms allowed banks to
classify unsecured loans extended to MFIs as good assets, allowing them to
restructure MFI loans without much difficulty. “We had approached RBI for debt restructuring in December last year. We have time till March 31 to approach banks,” Prasad said.  Some major banks like State Bank of India, ICICI and Axis Bank are estimated to have lent over Rs 15,000 crore to MFIs. While ICICI has lent around Rs 2,000 crore, SBI has loaned Rs 1,000 crore. Small Industries Development Bank of India (Sidbi) has an MFI exposure of around Rs 4,000 crore.

Decks cleared for bank licences to business houses

New Delhi, Mar 15: The government and the Reserve Bank of India
(RBI) are set to allow financial conglomerates and large industrial houses to
enter the banking industry.A bout half a dozen fresh banking licences are
expected to be given at one go to ensure that new entrants have a level playing
field, government sources said. The RBI recently submitted a set of proposals
on banking licences to the government. The final guidelines will be issued
after the finance ministry endorses the central bank’s draft.   Sources said that the new private sector entrants would be asked to open around 30% of their total branches in rural areas, as the government tries to calibrate commercial viability with financial inclusion.

Spl force likely for security to banks

PATNA: The state government is likely to create a special police force to extend security support to banks and nominate nodal police stations to tackle the menace of forged currency notes.  The decisions, among others, were taken at the State Level Security Committee meeting, convened by RBI Regional Director G Mahalingam here on Monday.  While Home Secretary Amir Subhani chaired the meeting, other participants included top government officials as well as officials of the RBI and banks. They felt that overall security situation for the banks has improved.  In another development, Mahalingam cautioned people against companies/entities mobilising deposits offering high rates of interest/return in the guise of Cumulative Convertible Preference Shares or even Cumulative Redeemable Preference Shares.  He said the RBI has not authorised such companies and entities to mobilise such deposits and, accordingly, the RBI does not guarantee repayment by these companies.

CM inaugurates Customer Service Point

Nagaland State Chief Minister, Neiphiu Rio on March 14 inaugurated Customer Service Point (CSP) of banking correspondent at Panchayat Hall Kigwema Village. In his inaugural speech he stated that the success implementation of this project would go to other villages of the state. He said that opening of this CSP Banking Correspondent is to provide loan to all the villagers of the rural areas and called upon the villagers to avail the opportunity. Today some people lent money at the rate of 10% per month whereas Bank provide loan at the rate of 1% per month, where Rio said that people lost their belonging or fail in their business due to high rate of interest charged by the public and encouraged the gathering to avail loan at the lowest rate of interest. Rio also said that college students are encouraged to open their Bank Account to draw their scholarship for easy transaction and further added that within six months about 50000 people has opened Bank Account in the state. He said that many of our people take loan and not pay/refund the loan in time. One must know the procedure to seek loan from the bank and pay back the loan in time, one must also get insured from the insurance company so that if their business failed they can get compensation from the company, Rio said. The inaugural programme was chaired by MLA, Advisor IT & C, Vikho-o Yhoshu while the invocation was pronounced by Pastor, Kigwema Baptist Church, Zhavi. Chairman, Kigwema Village Council, Zapuo Zhasa delivered the welcome address and AGM, State Bank of India, RBO Dimapur, A.K. Das gave a briefing on CSP. Short speeches were also delivered by K. Ashi Khieya OSD (Revenue) Finance Department, N. K. Gayan G.M RBI, Guwahati and Tilok Das DGM SBI Guwahati. Cultural item was also presented by Kigwema Village and vote of thanks was proposed by VDB Secretary Kigwema Village, Thorie.

Upward bias in interest rate: O P Bhatt

Ahead of the mid-quarter review of the monetary policy by Reserve Bank of India (RBI) on March 17, State Bank of India (SBI) Chairman O P Bhatt said there was an upward bias in interest rate. But he clarified that whether RBI chooses to tinker with key policy rates or keeps them unchanged would depend on its thinking and other factors, including external. "The current problem is not of liquidity, but inflation and the task is to balance growth and inflation.&" RBI has increased key policy rates seven times in 2010-11. He was at the 150 years celebration of SBI in Uttar Pradesh, and inaugurated 21 branches and 51 ATMs in Lucknow circle through video link. He also inaugurated the 300th customer service point in Lucknow circle.

RBI to rewrite FEMA notification on foreign investment

The Reserve Bank of India (RBI) is rewriting the 11-year old Foreign Exchange Management Act's (FEMA) notification on foreign investment.  The revised FEMA notification No. 20 will reflect the changes made to the FDI policies over the last 11 years. It will touch on the issue of securities by persons residing overseas. The notification will define control and ownership of an Indian company as in Press Note 2. It will also remove ambiguity on the definition of capital by excluding warrants and partly-paid shares and non-convertible debentures.  The new notification will have seven schedules and three annexures.

Interest rate futures: third time lucky?

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Mint

Tight liquidity forces banks to borrow more from RBI

MUMBAI: Advance tax outflows worth Rs 80,000 - 90,000 crore, coupled with year-end pressures to shore up their books, forced banks to borrow up to Rs 94,250 crore from the Reserve Bank of India on the first day after the reporting Friday. Banks are always looking at strengthening their balance sheets during this time of the year by shoring up their deposits and credit figures. This requires them to build up regulatory reserve requirements. Banks have to park a portion of the deposits they raise as cash with the central bank. As deposits gather pace, the cash requirements also go up, requiring them to raise funds from the market to meet the shortfall. Liquidity had begun to ease in the system after the government started spending, which is reflected in the government balances with RBI at minimum Rs 101 crore.  However, tight liquidity on account of advance tax outflows made it necessary for them to borrow from the Reserve Bank in repo by pledging securities. The traded volumes in the collateralised borrowing and lending obligation, or CBLO, market went up to Rs 66,633 crore from Rs 3,453 crore.

SBI CMD, OP Bhatt says merger of subsidiary units a time taking process

 LUCKNOW: The Chairman, SBI, OP Bhatt said that the merger of its subsidiary banks with the parent will not happen in one go and they will take it up one at a time. He said that though there are no roadblocks in the merger of its subsidiary banks it is a time taking process and certain steps need to be followed before a merger is initiated. He said that in the past the merger of two of its subsidiary banks with the parent, SBI, took about 2-3 years and therefore the merger of the remaining five subsidiaries would take about 3-5 years time. Also the merger would be subject to governmental clearances and addressing concerns if any raised by certain quarters about SBI becoming too big a bank for a balanced economic system, Mr Bhatt said on Monday on a visit to the state capital. With the Finance Minister proposing giving licenses to new private sector banks, Mr OP Bhatt said that a few more banks would only help the economy and there is enough space for each bank to grow. He said that the way the Indian economy is booming banking would also need to keep pace with the growth. In this scenario a few more banks which follow governance standards would only help in the overall growth of country. He said that the Indian banking system has proven itself to be strong and has been praised after the aftermath of Lehman Brothers, and the new banks would come up in a closely monitored sector. Mr Bhatt said that with inflation continuing to be a concern there seemed to be an upward bias towards an interest rate hike. Mr Bhatt who was here as part of SBI's 150th year celebrations, said that the bank had taken to spreading its network to the rural areas much before financial inclusion became a buzz word. He said that among other things they have introduced kiosk banking to spread its reach deeper into the rural parts of the country. He said that with economic progress trickling to rural India banking services were much needed in these remote locations. Also with many villagers still migrating to large towns, banking network was needed to send back remittances.

Subbarao's date

Assume for a moment that the Reserve Bank of India (RBI) did not have to come forward with any press release on monetary policy this coming Thursday. After all, there was a time when the central bank took a view on monetary policy only twice a year and it was not long ago that it yielded to the markets Q-culture. RBI Governor Duvvuri Subbarao, a half marathon runner himself, chose to become more quick footed in his responses and decided to come forward with a mid-quarter statement. While he did say in a recent speech that "Notwithstanding the scheduled quarterly and mid-quarterly reviews, we (RBI) reserve the right to alter our policy stance at any time to respond to the evolving macro-economic situation,&" the fact is that once a date for making a statement gets fixed, the RBI comes under pressure, from public expectations, to say something or the other. If there was no scheduled mid-quarter statement to be made this Thursday, the question of what signals the central bank would like to send on inflation management would not have arisen quite as sharply as it has. Should the RBI raise rates? If so, by how much? If not, why not? Such are the questions being asked. Given conflicting expectations of bankers, who dont seem to want a rate hike, and markets, that seem to expect a 25 basis points hike, it would appear the RBI has trapped itself into a position where it would be damned if it did, damned if it didnt.  Has inflation gone away as a problem? While economists seem divided both on this question, and the related one of whether monetary policy can address the problem, business expectations are that growth would be hurt by seeking to contain inflation through more rate hikes. In India, there is always some confusion about what indicator should be used to draw conclusions about inflation. If core inflation is to be the policy barometer, the jury is still out on whether or not current trend warrants a rate hike. Equally, credit growth has not gone out of control.  On the other hand, with sceptics questioning the Union finance ministers fiscal numbers, the RBI may feel obliged to act on the monetary side to rein in expectations. It is a Hobsons choice for the governor. If he had kept the option to respond when he must and when he can open, and not tied his hands by fixing a mid-quarter date, he may have been able to fudge his choices a bit more. With recent trade and industrial production data suggesting a slowdown in economic activity, and given current global uncertainties, this may have been a good time for RBI to lie low and wait, rather than act. If RBI had taken more decisive action last time, with a 50 basis points hike, it may have had good reasons for inaction at this time. Between no hike and a 25 basis points hike there isnt much choice. Since no one wants a higher hike, and RBI may not feel sanguine enough to avoid a hike, it may settle for a neither-here-nor-there compromise. Since there is a date, one might feel compelled to make a proposition!

RBI POLICY REVIEW: NAVIGATING ON THE CURVE

All eyes are on the Reserve Bank of India’s (RBI) midquarter monetary policy review on March 17. It has so far been aggressive in its actions, having raised policy rates seven times, and effectively increasing rates by 325 basis points (bps) since early 2010. The actual monetary transmission has been even more potent since market rates have been well above the repo rate owing to tighter liquidity conditions, even if we discount the fact that banks woke up late to transmit the hikes in policy rates.   The RBI will probably raise rates by 25 bps and stay the course with the hawkish bias. More open to debate is how much more aggressive is the RBI poised to be here on, as economic growth is most likely to moderate in 2011-12 even as trend inflation will be higher for longer. A gross domestic product (GDP) growth of 9 per cent in the next fiscal year despite an even more aggressive RBI appears to be an extremely low probability outcome. Moreover, given the global dynamics in commodities, more adjustments in local prices are likely, which, in turn, will sustain core inflationary pressures.  India’s improving headline inflation trajectory for much of calendar 2010 that followed from the severe drought of 2009 was thrown off course in December by the unexpectedly large hit from the fresh fruit and vegetables component of the wholesale price index (WPI). After hitting a high of 11 per cent year-on-year (YoY) in April 2010, WPI inflation eased to 8.1 per cent YoY in November, before reversing course to 8.4 per cent in December. The food composite index (weighted average of food components of the primary and manufactured goods subindices of the WPI) jumped in December to 8.6 per cent YoY after having declined to 6.8 per cent in November from 20.2 per cent in February 2010. Partly owing to government measures and improved supply, food inflation began to ease from the second-half of January. Indeed, the February WPI food inflation rate is likely to show a significant decline, though core inflation will rise. Despite the reams that were written on the jump in food inflation being triggered by improving affluence and existing structural deficiencies, one of the key drivers of the jump in inflation in particular was the fruit and vegetable category. The surge in the prices of that category alone contributed a massive 1 percentage point to the 8.4 per cent YoY inflation rate in December. It can’t be denied that a risk of a structural demand supply imbalance in the food economy remains, as policy initiatives have not enhanced agriculture productivity even as higher incomes have boosted demand. But this risk is not entirely new, and still asserts itself mainly via amplification of the impact of supply shocks, such as poor monsoons. However, the government needs to get its act together on this important issue.  It is often overlooked that India’s food inflation is not correlated with global food inflation. The claim by some that agood monsoon last year did not have a favourable impact on food inflation is incorrect, since food grain shows no pressure points owing to improved supply. So far, most of the structural pressure on food inflation has been concentrated in protein-rich food items such as eggs, meat and fish, and milk, which have been affected by improving demand and inadequate gain in supply. Indeed, eggs, meat and fish and milk categories together contributed half of the 8.6 per cent YoY increase in the food composite in December.  While food inflation is softening, core (in India’s case non-food manufactured goods) inflation is likely to increase, especially owing to the pass-through of higher global commodity prices to local prices. Depending on the magnitude of the pass-through, inflation and the government’s subsidy bill will be higher. While sensible economics dictates that the pass-through should happen, the schedule of state legislative elections suggests that a hike before that won’t be preferred, but some action thereafter is highly likely.  The RBI’s focus on WPI rather than the consumer price index (CPI) inflation means that core inflation will be quicker in adjusting upwards owing to the pass-through of higher commodity prices. The central bank is essentially trying to target prices of inputs and tradeables rather than final goods prices. Core inflation has already seen an uptrend in seasonally-adjusted sequential terms, but the RBI’s response appears to be more geared to the YoY inflation rate, possibly because that is what the public identifies with and reacts to.  Higher crude oil prices remain a legitimate risk to the inflation outlook, and inflation is likely to be higher for longer. Apart from local factors, a new global normal for commodity prices suggests that inflation is likely to be higher than what we have been used to. The adverse impact of high inflation on corporate margins will be more pronounced given the stronger presence of the cost-push drivers of inflation and softening aggregate demand.  However, some deceleration in economic growth will soften demand-driven inflationary pressures, and the spending restraint in the Budget will be a constructive input in inflation management. The likely slippage in the fiscal deficit does not necessarily mean that domestic market borrowing will necessarily increase, as the government could again increase the foreign institutional investment limit in local currency government debt. In any case, the slippage will come more into focus later in the year.  Unseasonal rains late last year upset the inflation trajectory, but, in my humble view, the RBI is not behind the curve. It has aggressively raised rates, but hasn’t formally targeted inflation, even if that means killing economic growth. Additionally, the uncertainty around the revision of administered fuel prices messes up the inflation trajectory. While managing inflation, the RBI is also ensuring that higher rates do not suffocate the much-needed supply enhancement in the supply-constrained economy. Also, the investment upturn in the current cycle is much weaker than in 2004-08, real lending rates are well in positive territory, and the actual monetary tightening is much more aggressive than what the current level of repo rate at 6.5 per cent indicates.  Thus, critics of the RBI overlook that the current monetary tightening cycle is dramatically different from that in 200708, despite the repo rate being lower now. The magnitude of the pass-through to higher local fuel prices remains a key unknown for mapping the inflation trajectory. Still, the full impact of the 325 bps tightening so far has not been fully transmitted, and some moderation in growth is already appearing even if the industrial production data overstate it. Since crippling growth is not on the agenda to win the inflation battle, the RBI will likely adopt a go-slow approach here on, unless sharply higher global commodity prices mess up everything. RAJEEV MALIK  -The author is a senior economist at CLSA, Singapore The views expressed are personal.