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.

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-          Amar Ranu

Equity Outflows dampened; Net assets grew to Rs. 6.65 lakh crore

In 2010 YTD, FIIs have been pouring money (referred as ‘hot money’) following the continuing global economic turbulence all over and thus, in some aspects, the inflows have been providing a temporary relief to burgeoning Current Account Deficits (CAD), expected to be over 3 per cent in current Fiscal Year. On the contrary, Mutual Funds have been bleeding seeing their assets depleting rapidly, especially Equity outflows. However, in Nov 2010, the situation improved in favour of domestic Mutual Fund Industry. On an average, the total industry AUM increased to Rs. 6.65 lakh crore, up by 2.92 per cent. Since the last four months, assets had been depleting continuously. The maximum growth was seen in Liquid/Money Market where the assets grew to Rs. 99,190 crore, a growth of 15.37 per cent over the last month.

Gilt Funds, where the investments are predominantly in Government Securities have seen an increased activity where a lot of investments flew in. The AUM grew to Rs. 4,410 crore, an increase of 11.08 per cent while the total inflows were Rs. 431 crore. This is the only category which has been witnessing positive inflows for the last 6 months. The high gilt yields scenario is throwing an opportunity for investors to reap the capital gains once the yields come down on account of eased liquidity situation, low inflation and improved economic outlook.

In Equity, the outflows continued albeit at much lesser amount. In Nov 2010, it saw an outflow of Rs. 41 crore only in comparison to an average outflow of Rs. 3,523 crore in last five months. The ELSS category too continued with the net outflow. This month, the outflow had been to Rs. 62 crore. In last eight months, the category saw the redemption of Rs. 993 crore, the maximum in recent years. However, the Balanced Fund category which involves a mix of Equity and Debt investments saw an inflow to the amount of Rs. 255 crore. However, its AUM declined to Rs. 18,871 crore in Nov 2010 from Rs. 19,462 crore in Oct 2010.

ETFs continue to move unidirectional with inflows. The Gold ETFs have drawn an added interest from investors which led to an inflow of Rs. 172 crore. In last 19 months, the category witnessed positive inflows in 18 months, the maximum among all categories. In other ETFs section, the inflows continued with a major addition of Rs. 328 crore. The AUM also rose to Rs. 1,852 crore in Nov 2010 from Rs. 1,690 crore a month earlier.

In Income category, the total AUM increased by 3.99 per cent to Rs. 3.31 lakh crore. The category saw an inflow of Rs. 11,307 crore in Nov 2010.

There were no new funds launched in Equity category; however, there was an open ended Gold ETF (Axis Gold ETF Fund) and Fund of Funds investing Overseas (JP Morgan EEMA Equity Offshore Fund) launched in Nov. However, there was a flurry of Fixed Maturity Plans (FMPs). A total of 36 FMPs was launched in Nov 2010 collecting a total fund of Rs. 5,281 crore. The liquidity deficit has sent the short term yields higher which have helped the Fund Managers to lock in the opportunity in dolling out FMPs which provide tax benefits in comparison to other investment products.

Source: MOSL

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