RBI 3rd Quarter Monetary Policy Review 2010-11 – Containing inflation to remain predominant objective

The RBI monetary policy soap opera verdict is out. The mixed global recoveries rather still subdued and the inflationary pressures in emerging market economies (EMEs) including India has been on the top of the radar of RBI in its Third Quarter Monetary Policy Review 2010-11. From the earlier stance of growth-inflation dynamics, the RBI moved to anchor the inflationary expectations likely due to sharp increase in the prices of primary food articles and the recent spurt in global oil prices.

Key Policy Measures:

•  Repo rate, the rate at which banks borrow from RBI, up by 25 bps at 6.5 per cent
•  Reverse repo rate, the rate at which the RBI lends to banks, up by 25 bps at 5.5 per cent
•  Cash Reserve Ratio (CRR), the portion of deposit that banks keep with the central bank retained at 6.0 per cent
• The inflation target revised upwards to 7 per cent from 5.5 per cent for march-end 2011
• The baseline projection of real GDP growth retained at 8.5 per cent with an upward bias.

Domestic Outlook

The domestic economy is on strong trajectory path as revealed by the 8.9 per cent GDP growth in the first half of 2010-11 powered mainly by domestic factors including strong consumption. The strong agricultural output on satisfactory kharif production and higher rabi sowing will contribute significantly to overall GDP growth in 2010-11. The industrial output also showed buoyant figures; however, the significant volatility adds uncertainty to the outlook.

Inflationary Concerns

The headline inflation as measured by WPI remained uncomfortably high since Jan 2010. Although it moderated between Aug and Nov 2010, it reversed in Dec 2010 mainly due to sharp increase in prices of vegetables specially onion, tomatoes, garlic etc and petrol prices. The current inflation level is also contributed by structural demand-supply mismatches in other cereal items. Considering all the scenarios, the baseline projection of WPI inflation for March 2011 has been revised upwards to 7 per cent from 5.5 per cent earlier. The sources of price pressure – fuel and non-fuel commodity prices and some food items could be non-responsive to RBI monetary policy actions. Going forward, the price level will depend how the global and domestic prices evolve.

Liquidity – still in deficit mode

Since the outflows caused due to 3G and WIMAX payments, the liquidity remained in deficit mode in the financial system. Also, the sluggish deposit growth, far below the RBI projection along with the non-food credit growth of 24.4 per cent worsened the liquidity in the system. Meanwhile, the RBI also intervened by cutting SLR by 1 per cent and initiated OMO transactions worth Rs. 67,000 crore. The additional liquidity support to banks up to 1 per cent of NDTL has been extended up to April 08, 2011. Under this, the bank may seek waiver of penal interest purely as an ad hoc measure. The 2^nd LAF will be conducted on a daily basis up to April 08, 2011.

Burgeoning CAD (Current Account Deficits)

The current CAD expected to be around 3.5 per cent of GDP is not sustainable as feared by RBI. CAD, an outcome of net exports and imports may get worsened further if the global recovery improves. Till now, the capital flows, which so far have been broadly sufficient to finance CAD may get adversely affected as the global recovery can trigger the flight to safety.

Global Scenario

There has been a significant improvement in global growth prospects in recent weeks; however, the recoveries are still fragile with uneven scenarios in Euro region and Japan. The deflation fears looming largely on advanced economies got some reprieve with early signs of inflation. The real GDP growth in the US improved to 2.6 per cent in Q3 2010-11 after witnessing a muted growth in 1.7 per cent. The retail sales and corporate capital spending has improved. Unlike in advanced economies, Emerging Market Economies (EME) has been affected by burgeoning inflation trends due to spurt in global food prices including a spurt in crude oil. 

With better signs of sustainable recoveries, the global growth in 2010-11 is anticipated to be less frictional and will show firm signs of sustainable recoveries. With rising prices on increased demand, inflation would be a global concern in 2011.

Why the rate hikes?

The market had been anticipating a tougher stand from RBI as the inflationary issues failed to settle down. While the market had mixed anticipations – 25bps vs 50bps hike, the RBI followed a calibrated approach – hiking the policy rates by 25 bps only – after taking a “comma” stand for few weeks in its policy rate hikes. The current policy rate is still below the pre-crisis level. Since March 2010, it has increased rates by six times. Also, keeping the LAF corridor at 1 per cent, the RBI intended to bring down the volatility in overnight rates within the corridor.

Happy Reading!

-          Amar Ranu

A new ranking for Universities in Economics

Economics lovers!

A new ranking is in place for the best department of Economics in globe; it is based on online voting. Alas! It does not include any Indian university; however, it includes an Asian University i.e. National University of Singapore. Massachusetts Institute of Technology (MIT) tops the chart followed by Harvard University and University of Chicago. For more, click here.

So, Economics lovers! Go and grab your choice university; of course, the admission comes with their tough admission patterns. :)

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How the ranking has been done?

- A total of 58,013 votes are taken which includes almost all major locations of the globe. The maximum numbers of voters are from North America followed by Europe. The rest are from South Africa, Australia, New Zealand and Asian Countries too.  Out of the blue it includes New Delhi too.

- Overall total number of submitted ideas = 183

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Disclaimer: This project, All Our Ideas is financed by grants from Google and CITP at Princeton
University. It is a research project to develop a new form of social data collection that combines the best features of quantitative and qualitative methods. 

Happy Reading!

-         Amar Ranu

How many zeroes can you think of – Try Zimbabwe Bank notes and play in Billions or Trillions

Imagine a situation – a $ 5 could buy you enough bread in India while in Zimbabwe, back in 2008, 700 million Zimbabwe dollars bought a loaf of bread. Playing in Billions/Trillions had been a fun in Zimbabwe until the government abandoned its currency in early 2009 and decided to revalue its currency, removing 12 zeroes. Now, 1 trillion in Zimbabwe dollars is equivalent of one Zimbabwean dollar. Under the new valuation, the largest note is a 500-dollar Zimbabwean dollar. Earlier, the largest Zimbabwean bank note was for 100 trillion dollar (wow...hope India would become a $ 100 trillion dollars soon) and one U.S. dollar was worth more than 300 million Zimbabwean dollars. 

Hyperinflation or Deflation?

Currently, the world is divided into groups – with one set of countries majorly developed states flirting with the deflation and another set of countries majorly developing states like China, India etc battling to control burgeoning inflation. India has a serious concern on inflation due to structural issues on which the central bank has raised it many times. Recently, the RBI governor D Subbarao commented – “When I meet other central bank governors, they tell me `why don't you give us a bit of your inflation. That's how desperately they want some inflation and how desperate we are to control inflation”.

The hyperinflation has its own history.  Prof. Steve H. Hanke, Professor of The Johns Hopkins University and Senior Fellow of The Cato Institute has calculated the highest monthly inflation data as given below:

So, it is not only Zimbabwe but other countries like Hungary and Germany have also faced the hyper inflation in the past. Still, Hungary holds the record with the highest monthly inflation rate in the past. 

Now soiled Zimbabwean Dollars find new takers..

Western visitors to Zimbabwe are looking for zeros. They are toying with the soiled Zimbabwe bank notes, not in circulation now, most notably the one hundred trillion Zimbabwe dollar bill as an economic souvenir. The report says

The one hundred trillion Zimbabwe dollar bill, which at 100 followed by 12 zeros is the highest denomination, now sells for $5, depending on its condition. That bill and others -- among them millions, billions and trillions, were abandoned nearly two years ago, when the American dollar became legal tender in the hopes of killing off the record inflation that caused all those zeros.

"I had to have one," said Janice Waas on a visit to the northwestern resort town of Victoria Falls. "The numbers are mind bending." She got her so-called "Zimdollar" in pristine condition, from a street vendor who usually sells African carvings.

Call it the passion or curiosity; everyone now wants to get a pie of it. No wonder inflation – be it hyperinflation or deflation is a weapon of mass devastation. Hope in India, someone must be listening!

Happy Reading!

- Amar Ranu

Cash Strapped or Cash Hoardings – Look at these numbers

The world might be running high of rising asset prices and abundant liquidity which have heightened the inflation across the world. Last day, the republic of China raised its bank reserve requirements by 50 bps, the sixth time in less than a year and 4^th time in last 2 months in order to tame the inflation. Liquidity in the financial system has been another issue around the globe after the financial crisis. However, it eased after the developed countries announced a series of quantitative measures to ease the situation with US coming out with TARP, QE-I and now QE-II.  Sovereign crisis fear the European region which has questioned the existence of a unified region.

Amidst all these developments, many financially sound companies or marginally affected due to globe hoarded the money awaiting the new ideas for which they hoarded the cash in large quantum. The VRS Research team at Standard & Poor with the help of Capital IQ data examined the top 50 publicly traded companies globally, excluding financials, ranked by their latest reported quarter’s total cash and short-term investment holdings. The sum total for these companies’ cash balances is approximately US $ 1.08 trillion, almost near to cash holding for the entire S&P 500 Index.

We found 17 U.S.-based companies among the top 50 global corporate cash holders--which means that among specific nations, two-thirds of the top 50 global cash holding companies are headquartered outside of the U.S. From the perspective of dollar amounts, the 17 U.S companies account for $458.2 billion, or about 42%, of the top 50's global cash holdings. Meanwhile, the cumulative cash holdings of the 13 companies located in Asia and Australia, among the 50 below, amount to more than $270.1 billion, or about 25% of the group's total. In Europe, we find 17 companies among the top 50 global cash holders with aggregate cash holding total of $287.7 billion, or about 27% of cash balances among the global top 50.

With the abundance of capital abroad, there is a likelihood possibility that the firms may go for increased cross-border mergers and acquisitions as well as for strong earnings growth outside the U.S. After 2008 crisis, this domain has almost died given the tight liquidity scenario in their home country and globally. However, currently, the list could serve as a starting resource for ideas on who may be buying, where deals could occur, and possibly where profits may emerge.

Happy Investing! Happy Reading!

-        -   Amar Ranu

(Permission sought from S&P to post their articles on this blog)

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TINA plus S – Curve Effect = M100, a Midcap ETF

After the success of MOSt Shares M50 ETF, the fundamentally managed ETF and the remixed version of Nifty 50 which created record in terms of largest number of ETF investors, Motilal Oswal Asset Management Company Ltd. (MOAMC) has come out with a unique and novel product MOSt Shares M100 ETF having TINA (There Is No Alternative) and S-Curve effect. It is India’s first mid cap ETF based on CNX Midcap Index.

Mid Cap Space – unfilled opportunity for investors

Investors have always been scouting for mid cap space for better returns in comparison to large cap stocks, even at a higher volatility. Many fund houses sensed this opportunity and introduced active mid-cap funds; however, most of them failed to beat their benchmark, categorically CNX Mid Cap over a longer period of time. Moreover, the high expense costs (on an average 2.1 per cent) for these funds have been eating their returns. So, practically, investors have been left with no option but to invest in these funds relatively at higher costs.

MOSt Shares M100 ETF

MOAMC known for its innovations have filled this gap with the launch of MOSt Shares M100 ETF, India’s first mid cap ETF based on CNX Midcap Index. The primary objective of the scheme is to seek investment return that corresponds generally to the performance of the CNX Mid Cap Index, subject to tracking error. 

Why M100 ETF with CNX Mid-Cap Index?

1)     The Fund proposes to keep the expense ratio within 100 bps unlike in active funds which have 2 per cent plus.

2)     In longer investment period say 3 years and 5 years, CNX Mid Cap has outperformed the average midcap fund by a good margin.

3)     The volatility of CNX Mid Cap Index (25.5 per cent) is less than Nifty 50 (26.1 per cent); so, you are getting higher returns even at lower risk.

4)     None of the constituents of CNX Mid Cap has more than 4 per cent exposure in the index; so, they are avoiding concentration risk, an important factor if the market moves uneven.

5)     CNX Mid Cap Index is driven by consumption growth story with majority exposures to HealthCare, FMCG, Auto, Construction etc; so, in long term, the index is going to perform better in comparison to other indices.

6)     Being an ETF, it trades like a share and acts as a fund with no entry and exit loads and portfolio disclosed on daily basis.

TINA and S-Effect

Frankly speaking, the TINA affect applies here – There Is No Alternative to this product in the market. Historically, CNX Mid Cap has bitten its large index counterpart in long year’s category. So, logically, the investors will get exposure in Mid Cap stocks at lesser costs (1 per cent – proposed). Moreover, the S-Curve effect applies to mid-cap stocks – from inception to high growth to maturity i.e. Small Caps -> Mid Caps -> Large Caps. These hidden gems are under-researched, under-owned and under-valued. So, they provide a good growth opportunity in future. 

Word of Caution

1)     Mid cap stocks provide better returns in comparison to large cap companies; however, they have the downside effect too in bear market. However, investors planning to hold for longer years (minimum of 3-5 years) can get good returns over Large Caps.

2)     The proposed expense ratio (up to 1 per cent) is a win-win situation for investors; however, the fund house may go for the maximum permissible expense of 1.5 per cent which can deter the performance. However, it is still below the average expense ratio (over 2 per cent) of active mutual funds.

Should you buy?

First of its kind, the mid cap space has always been dominated by active funds. However, with the availability of this product, the investors fraternity must be excited to get exposures in mid cap stocks at comparatively lesser costs.  Also, the ETF story has started running in India which generally works at lower costs and in the long run, the history says that passive funds work better than an active funds. No doubt ETFs are going to bang in coming years.

M100 rocks!

Happy Investing!

- Amar Ranu

Fiscal Deficits at sub-5.5 per cent vs Higher Borrowing – which one to stick with?

Too many cooks spoil the broth! Rightly said... Post the global financial crisis, many countries – developed and emerging economies went for expansionary monetary and fiscal policies to revive their slowing economy. In India too, the slowdown of economy forced the Central Bank, the RBI and Central Government to announce a series of monetary and fiscal policies which shook the Indian Government’s finances. Three major expenses like provision for Sixth Pay Commission, Loan Waiver and MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Program) and various other subsidies including policy rate cuts led to significant intensification of the India’s Fiscal Deficit.

These unplanned expenditures in terms of loose policies and subsidies have badly affected the fiscal deficits. For Fiscal Year 2010-11, the Central Government fiscal deficit and combined gross fiscal deficit have been pegged at 8.2 per cent. However, there is an apprehension that it can shoot up further. In FY 2009-10, the fiscal deficit was 6.8 per cent of GDP. For FY 2011-12, it has been projected to bring it down to 4.4 per cent.

So, what happens if the fiscal deficit shoots up?

It means that the government will borrow extra to finance their planned and unplanned expenditures. If the government borrows extra for its spending, the level of money supplies rises which may compel to print more money, thus, leading to a hike in inflation rate. 

Current Scenario

With the improvement in economic conditions, the RBI has rolled back many of its accommodative measures introduced in year starting from 2008-09 bringing the policy rates to pre-crisis level. The net borrowing of Rs. 3.81 lakh crore will be executed smoothly except at few occasions where it has been devolved to PDs. However, the 3G and WIMAX auctions which collected worth Rs. 75,000 crore created the liquidity fissures which became a daily headache for RBI. In many occasions, the RBI has reiterated its comfort in repo borrowing up to 1 per cent of Net Demand and Time Liabilities (NDTL). However, the borrowing has been in range of over 2 per cent of NDTL which prompted the RBI to cut the SLR to 24 per cent and also introduced bond repurchase worth Rs. 48,000 crore under OMOs in four tranches.

The tight liquidity scenario was contemplating that the government may go for cancellation of some of its regular weekly borrowing as it has some unspent revenues lying with them. However, the Finance Ministry found support after the Nominal GDP data was released which rose on high inflation and on account of new series in headline inflation as measured by WPI. The nominal GDP
which expanded 19.8 per cent in the first half of the fiscal year 2010-11 provides the room for additional borrowing if the growth rate is intact in the 2^nd fiscal and the budgeted borrowing would amount to 5 per cent of the GDP only. The nominal GDP figures have risen due to burgeoning high
inflation rates which have been in double for most part of years and a new inflation index i.e. 2004-05. 

View

Since the fiscal numbers are calculated in current prices and if the government sticks to the number plan, it may have an additional room to borrow. The 5.5 per cent budgeted Fiscal Deficit of the GDP was thought of on account of assumption of 12.5 per cent growth in nominal GDP. However, it has grown at 19.8 per cent in the first half of the FY 2010-11; so the government may announce in reduction of Fiscal Deficit number at sub-5.5 per cent or may go for additional borrowing.

Given the tight liquidity scenario, it is unlikely that they will go for additional borrowing.  However, the quantum of OMOs done totaling Rs. 41,266 crore (in four tranches) may give a reason to borrow again beyond the budgeted specified limit if the liquidity improves in the financial system so as to finance its social schemes. After all, the election preparation is on!

Happy Reading!       - Amar Ranu

Financial Stability Report 2010 – A well documented story on Indian Economy

The Central Bank, Reserve Bank of India released its 2^nd Financial Stability Report (Firstone released in March 2010) and thus, it enters into the selected league of countries which publish Financial Stability Review/Report on a periodic basis. In the wake of the global economic crisis, it has become prudent for the Central Banks across the global to assess their financial stability and conduct many stress tests so as to test the nerves of the economies.

Broadly, the report covers that the financial sector remains stress free; however, the intermittent capital flows poses a big challenge as these kinds of flows are very volatile and may get reversed at time of extreme volatilities in origin countries. However, these portfolio inflows have helped financing the burgeoning current account deficit.

It also cautioned that the global economic recovery remain uncertain especially the European region needs to be watched out. Prolonged low interest rates in developed countries encourages higher systematic leverage and also creates a yield seeking environment wherein investors get into crowded traded.

The report also pointed out some soft domestic points where an eye needs to put up. While the domestic growth remains buoyant, the high domestic inflation is a cause of concern due to structural issues. The downside risks still remain and the stressed liquidity conditions warrant caution too. The bubble up in housing sector, especially in some particular regions like Mumbai, Noida, Bangalore and
other cities have prompted tightening of prudential norms which included increasing the provisioning ratio and raising the LTV ratio for higher loans. Read more…

2010 would be remembered a year in Financial Regulation with the passing of Dodd-Frank Act in United States to regulate banks and other financial institutions. We hope that the Central Bank will come with regulations in untouched domains and will take them under their umbrella.

Also read other countries Financial Stability Report/Review which are given below:

Austria – Dec 2010

Canada – Dec 2010 & June 2010

China – Sept 2010

Chile – Sept 2010

ECB – Dec 2010

Germany - 2010

Global by IMF – July 2010

Greece – July 2010

India – Dec 2010 & March 2010

Ireland – 2007

Italy – Dec 2010

Mauritius – Dec 2010

New Zealand – May 2010

Portugal – Nov 2010

Singapore – Nov 2010

South Africa – Sept 2010 & March 2010

Taiwan – May 2010

UK – Dec 2010

Happy Reading!
- Amar Ranu