Archive

from Global Investing:

Battered India rupee lacks a warchest

The Indian rupee's plunge this week to record lows will have surprised no one. After all, the currency has been inching towards this for weeks, propelled by the government's paralysis on vital reforms and tax wrangles with big foreign investors. These are leading to a drying up of FDI and accelerating the exodus from stock markets. Industrial production and exports have been falling.  High oil prices have added a nasty twist to that cocktail. If the euro zone noise gets louder, a balance of payments crisis may loom. The rupee could fall further to 56 per dollar, most analysts predict.

True, the rupee is not the only emerging currency that is taking a hit. But the Reserve Bank of India looks especially powerless to stem the decline. (See here for an article by my colleagues in Mumbai) .  One reason  the RBI's hands are  effectively tied is that  India is one of the few emerging economies that has failed to build up its hard currency reserves since the 2008 crisis and so is unable to spend in the currency's defence. Usable FX reserves stand now around $260 bilion, down from $300 billion just before the 2008 crisis.  See the following graphic from UBS which shows that relative to GDP, India's reserve loss has been the greatest in emerging markets.

But there is worse. The relative decline in reserves since 2008 coincides with a ballooning in India's external debt, both private and public. Comprising mostly of corporate borrowing and trade credit, the debt stands at $350  billion, up from $225 billion four years back.

No wonder investors have upped their bearish bets on the rupee: a Reuters poll of Asian fund managers shows these at a six-month high and significantly higher than any other Asian currency. For now, the trade  looks worryingly like a one-way street.

from Expert Zone:

Investors shouldn’t read too much into repo rate cut

(The views expressed in this column are the author's own and do not represent those of Reuters)

The last time the Reserve Bank of India (RBI) surprised the markets was when it announced a 75 bps cut in cash reserve ration (CRR) days before its mid-quarter review of monetary policy on March 15. It did so again in its annual monetary policy meeting on April 17, with a 50 bps repo rate cut when the markets were either expecting no rate cut or a 25 bps rate cut at best.

Why did the RBI cut the repo rate by 50 bps, amid growth showing signs of a recovery and the general belief that the worst in industrial growth was already behind us; when food inflation had started rising and with all the suppressed inflation in retail fuel, coal, power and fertiliser prices?

Did it give in to moral persuasion from the government and the industry? Or was it because cutting rates later in the year would have been difficult, if not impossible? As if to mock the rate cut, consumer price inflation for March came in at 9.5 pct the very next day.

As per media reports on April 19, the Commission for Agricultural Costs and Prices (CACP) recommended a hike of 15-40 pct in the minimum support price (MSP) of various kharif crops during FY13. Though these are just recommendations, historically, the actual hike in MSP has almost matched the recommendations. This is again likely to add to food inflation. With the current account deficit likely at 4 pct of GDP in FY12 putting further pressure on domestic currency and the consequent need for overseas inflows to finance the same, a rate cut was the last thing that should have been done.

Also, the uncertainty relating to monsoons, spike in food inflation after the transitional decline in Dec and Jan 2012 and the impending retail fuel price hikes, all create doubts over the continuance of the trend in the foreseeable future.

The RBI Governor said “the reduction in the repo rate is based on an assessment of growth having slowed below its post-crisis trend rate which, in turn, is contributing to a moderation in core inflation. However, it must be emphasised that the deviation of growth from its trend is modest. At the same time, upside risks to inflation persist. These considerations inherently limit the space for further reduction in policy rates.”

from Expert Zone:

RBI rate cut — too little, too late?

(The views expressed in this column are the author's own and do not represent those of Reuters)

The RBI Governor cut the repo rate on April 17 quite reluctantly, even hinting there wouldn’t be another cut soon. Perhaps, he was under pressure from elsewhere, compelling him to look beyond inflation which had been his sole criterion in raising the repo rate.

The surprise was that the RBI cut the rate by 50 bps in one go. What the market expected was 25 bps because that is the speed at which the RBI has been moving since March 2010, except on one occasion   when the rate was raised by 50 bps. Will the drop in repo from 8.5 to 8 percent make all the difference?

A 50 bps reduction does not mean that banks will slash their interest on credit correspondingly. After all, the repo is the rate at which banks borrow from the RBI. These borrowings are a small part of their total operations. What matters more is the interest on deposits which banks may take some time to reduce. Therefore, at best, the reduction in interest on credit can be 25 bps. That is unlikely to rev up the debt market.

Take home loans which are generally for long periods and therefore the interest rate becomes an important consideration. On a loan of 2 million rupees payable in equal instalments over 20 years, the saving in interest with a 25 bps reduction would be 170 rupees a month. That is too little for any home buyer to be excited about. That is also true of the corporate sector though the stock market reacted favourably.

The cut in the repo rate is nevertheless a good beginning. But it has to be carried forward before it can regenerate investment and the economy. The RBI had done it in 2008 when the economy had slowed down following the world financial crisis. The repo rate was 9 percent in 2008 when Lehman Bros collapsed and the RBI cut it by 100 bps in October. That was followed by another 50 bps cut in November and 100 bps in December. In just three months, the repo was down 250 bps from 9 to 6.5 percent. Not that there was no inflation. Going by WPI, inflation was 12 percent in August 2008 which declined thereafter in spite of the sharp cut in interest rates. But consumer prices, mainly due to food inflation, were high. Food inflation is a problem by itself unrelated to the rate of interest.

The choice before the RBI is really to have a high interest rate with low growth and high inflation or to have low rate of interest with high growth and high inflation. The latter would be a better choice. That would require that, as in 2008, the repo rate has to be cut not by 25 or even 50 bps but by 100 bps to get it down to 6.5 percent in the next three months and take investment back to 30 percent of GDP.

from Expert Zone:

Cost of a rate cut delay in India

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The RBI took the first step to ease monetary policy by reducing CRR by 50 basis points on Jan. 24. However, it postponed an interest rate cut, in spite of the advice by the special committee, only to confirm its reputation of being cautious. But excessive caution can also cost the country a pretty penny.

Since then, there have been further developments. Liquidity in the system has been drying up and the RBI has been using open market operations to buy government securities in exchange for cash. That helped maintain the yield on long-term government securities within narrow limits though on short-term debt, like treasury bills, the government had to pay higher interest.

In recent weeks, inflation has climbed down from 9.1 pct in November to 6.7 pct in January. But while the RBI had been quick to raise interest rates with every point increase in inflation, it has been hesitant to cut rates in spite of easing inflation.

The obsession with high rates is causing growth to suffer. Last December, growth in industrial production was a mere 1.8 pct. That was mainly because of the 16 pct fall in capital goods production which reflects the sharp decline in national investment. In July-September 2011, for instance, national investment y-o-y was down from 30.3 pct of GDP to 28 pct. The main reason for holding back investment and income was the sharp increase in interest rates.

Interest rates rose to 8 pct in July 2011 from 5.75 pct in July 2010. Broadly, the rise of 225 basis points in interest rates caused national investment to shrink by 621 billion rupees in the July-Sept quarter of 2011 leading to a GDP loss of 1.03 trillion rupees.

The RBI has been careful to ensure that the interest rate for the government did not increase commensurately. Although the repo rate was up from 4.75 pct at the beginning of inflation to 8.5 pct now, the yield on 10-year government bonds moved in the range 8 - 8.5 pct. The RBI has been buying dollars or buying government securities to replenish liquidity. The full brunt of the rise in interest rates was borne by the private sector either by corporates on bank credit or by individuals on home or car loans.

from Global Investing:

Without real sign of rate cuts, Indian equity rally still fragile

Indian equities are among the best emerging markets performers this year, with the Mumbai market having posted its best January rise since 1994. That's quite a reversal from last year's 24 percent slump. The bet is faltering economic growth will force the central bank to cut interest rates from a crippling 8.5 percent. So, how safe is the rally?

Some conditions are already in place. Valuations look decent after last year's drop. There has been a surge in global investors' appetite for emerging market assets. So Apurva Shah, who helps manage $600 million at the BNP Paribas Mutual Fund in Mumbai, expects positive returns from Indian stocks this year. But for a decent rally to be sustained, interest rates have to fall in order to kickstart faltering growth, he says.

The risk is really the assumption that interest rates and inflation are actually on the way down. We've seen the first leg of that happening, but it's just the beginning. Rates are still way too high. To trigger off any real revival in economic growth they need to fall a lot more.

The market may be pricing Indian interest rates to fall between 75 to 100 basis points this year but there is little indication this will actually happen. The central bank, the most hawkish in the developing world, has cut reserve requirements and voiced concern about growth. But a senior central bank official has made clear only a sustained fall in inflation will prompt a rate cut.

Inflation is indeed easing but elevated food prices, infrastructure bottlenecks, and the government's seeming inability to cut back on budget spending mean the battle is not over yet.  Shah says that for the time being he is sticking to long positions in consumer stocks with a domestic focus, including consumer banking companies, and shying away from rate-sensitive stocks such as state-controlled wholesale banks. That will change if rates actually start to fall.

There have been a few false starts in the past, so we will want to be doubly sure that it's actually happening

(By Alessandra Prentice)

from Global Investing:

India: the odd BRIC out

China moved to ease policy this week via a reserve ratio cut for banks, effectively starting to reverse a tightening cycle that's been in place since last January. Later the same day, Brazil's central bank cut interest rates by 50 basis points for the third time in a row. Both countries are expected to continue easing policy as the global economic downturn bites. And last week Russia signalled that rate cuts could be on the way.

That makes three of the four members of the so-called BRIC group of the biggest emerging economies. Indonesia, the country some believe should be included in the BRIC group, has also been cutting rates. That leaves India, the fourth leg of the BRICs, the quartet whose name was coined by Goldman Sachs banker Jim O'Neill ten years ago this week. India could use a rate cut for sure. Data this week showed growth slowing to 6.9 percent in the three months to September -- the slowest since September 2009. Factory output slowed to a 32-month low last month, feeling the effects of the global malaise as well as 375 basis points in rate increases since last spring. No wonder Indian stocks, down 20 percent this year, are the worst performing of the four BRIC markets.

But unlike the other BRICs, a rate cut is a luxury India cannot afford now -- inflation is still running close to double digits.  "The Reserve Bank of India (RBI) is the odd guy out due to stubbornly high inflation of near 10 percent," writes Commerzbank analyst Charlie Lay.

True, inflation in the other BRICs is also running above target. But nowhere is it as stubborn as in India, and that is due to antiquated infrastructure and supply side bottlenecks. Half-hearted policy reforms means this will remain a problem. Where India differs from the other BRICs is also its large current account deficit of over 4 percent of GDP. This was one reason why the rupee was the hardest hit emerging currency during the November selloff, losing almost 7 percent. Its depreciation adds 30-50 basis points to headline inflation, analysts reckon.

But inflation is broadly expected to start easing from the second quarter of 2012, allowing the RBI to follow other emerging markets and finally start cutting rates. For now though, the best that can be hoped for is that rapidly cooling growth will force the RBI to keep interest rates on hold.

from Global Investing:

Good reasons for rupee’s fall but also for recovery

It's been a pretty miserable 2011 for India and Tuesday's collapse of the rupee to record lows beyond 52 per dollar will probably make things worse. Foreigners, facing a fast-falling currency, have pulled out $500 million from the stock market in just the last five trading sessions.   That means net inflows this year are less than $300 million, raising concerns that India will have trouble financing its current account gap.  The weaker currency also bodes ill for the country's stubbornly high inflation.

Why is the rupee suffering so much? First of all, it is a casualty of the general exodus from emerging markets. As a deficit economy, India is bound to suffer more than say Brazil, Korea or Malaysia.  And 18 months of interest rate rises have taken a toll on growth.

UBS analysts  proffer another explanation. They point out a steady deterioration in India's net reserve coverage since the 2008 crisis. The reserve buffer -- foreign-exchange reserves plus the annual current account balance, minus short-term external debt -- stands at 9 percent of GDP, down from 14 percent in 2008.  Within emerging markets, only Egypt, Venezuela and Belarus saw bigger declines in net reserve coverage than India.

"What it really means for the present, in our view, is that the rupee is now joining the ranks of higher beta “risk” currencies," UBS said.

Still not everyone is overly perturbed. Some expect the rupee to rebound as the global picture improves. One reason is that the rupee is generally seen as undervalued in nominal terms, as well as on purchasing power parity (PPP) basis, more so than most emerging currencies. The latter is the rate at which one currency would convert to another to buy the same amount of goods and services in each country. On that basis the Indian rupee would equate to 20 to the dollar, data from the World Bank/IMF shows.  Given the strong underlying story, investors are more likely to buy back the rupee than say the South African rand when risk appetite improves.

Furthermore, Indian equity valuations are looking more reasonable than before, despite the slowing economy. Stocks trade now around 12 times forward earnings, compared to 17 times a year ago. That should lure some overseas cash once the dust starts to settle.

"This may not be bottom of the market but for us, investing at these levels of currency and equity valuations is an attractive proposition," says Phil Poole, head of global and macro strategy at HSBC Global Asset Management.

from Expert Zone:

The end of repo rate hike?

(The views expressed in this column are the author’s own and do not represent those of Reuters)

Apparently, the RBI is exasperated. After 18 months of inflation and 13 hikes in repo rate, RBI Governor Duvvuri Subbarao more or less admitted a day before Diwali that the pursuit of interest policy had gone far enough even though it hardly made any different to inflation and only deflated the growth rate instead. But he is not without hope.

The RBI believes that inflation will begin to decline from December, reach 7 percent by March and ease further in the first half of 2012-13. What has made the RBI indulge in these amusing predictions is not convincingly explained. Having been accused of pulling down growth, the RBI also expects that investment will pick up once inflation is pushed down, suggesting that a reversal of monetary policy will follow.

Undoubtedly, the RBI, like other central banks, is charged with the responsibility of maintaining price stability. For the RBI, inflation is the principal target of policy and interest rate the most preferred weapon. Three years ago in July 2008, India had inflation exceeding 11 percent and the RBI had kicked up the repo rate to 9 percent. In just three months, inflation took a plunge -- not so much in response to the interest hike as from the impact of the world financial crisis in September of that year.

Besides, the inflation of 2008 was intrinsically different from the inflation of 2011. The earlier inflation originated in the industrial sector and did necessitate an interest hike to cool it down. The present inflation is largely due to supply deficit of select agricultural commodities. The RBI was fully aware that the present inflation required government intervention much more than its own. But the government wholly relied on the RBI.

The supply deficit is in respect of protein-rich foods like milk, pulses, fruits and vegetables, and meat and eggs. That reflects an ongoing change in people’s consumption pattern, from carbohydrates to proteins, induced mainly by improvement in incomes. No wonder per capita consumption of cereals has been static in the past 5 years. What is critical is that the demand-supply gap in these protein-rich foods has not narrowed and the RBI may not be quite right in presuming that inflation will decline from December and taper down in the first half of the next year.

Indications are that food inflation has become almost chronic. Even though supply is increasing, demand for select foods is increasing even faster, preventing inflation from easing. The repo rate can hardly make any difference to that demand. But supply can be increased much more if governments extend facilities to farmers like interest subsidy, improved seeds, etc. and create an environment for efficient marketing and reduction in distribution cost.

from Expert Zone:

Two problems, one strategy for both RBI and the Fed

(The views expressed in this column are the author's own and do not represent those of Reuters)

The Reserve Bank of India and the U.S. Federal Reserve were confronted with two different problems but used the same monetary strategy for solution. Neither succeeded.

The RBI had to pull down inflation and raised the repo rate in eleven steps in eighteen months by 3.5 percent. The expectation was that the rate rise will curb demand and lower prices. What happened was entirely different.

Headline inflation is still over 9 percent, largely backed by inflation in food, mainly fruits and vegetables, meat and eggs. Interest rate made no difference to food inflation because no one buys food from money borrowed from banks.

But the RBI did succeed in curbing demand for a variety of other products. With the high interest rate, demand for housing declined and construction activity slowed down. With the high interest rate, demand for cars and trucks dropped and production became stagnant and would even shrink. With the high rate of interest many industrial projects became unviable and investment declined. And so on.

All in all, GDP growth in the second quarter was down to 7.7 percent from 8.8 percent y-o-y. This was precisely what the RBI was looking for. But it had also expected that, with lower growth, inflation would fall. That did not happen simply because inflation was not due to over-heating of the economy but shortfall in critical food supply.

The Fed was expecting exactly the opposite to be achieved with the same strategy. The rate of interest was drastically cut and the Bank poured in trillions of dollars to keep that rate in check, hoping that investment and consumption will revive and unemployment will be reduced. Neither took place.

from India Insight:

RBI chief challenges “group wisdom” on economy

India's central bank chief Duvvuri Subbarao may not be an established economist or a career banker, but he has a rare set of skills -- of an administrator, non-conservative thinker with degrees in physics and economics -- who can take on the group wisdom of economists and markets.

While delivering an address on “Role of Economics in Policy Making” at the golden jubilee function of the Indian Economic Service -- the career economists in Indian administration -- he said they were challenging the wisdom of “celebrated” economists and economic models.

That may be the reason why Subbarao was probably alone in opting for a 50 basis points rate hike in July while the majority of panel members favoured a pause in monetary tightening or at the most a 25 basis points rise in rates.

The Reserve Bank of India (RBI), headed by Subbarao, is one of the most aggressive inflation fighters among central banks, and has raised rates 11 times since March 2010, though inflation still remains at over 9 percent.

India’s finance minister Pranab Mukherjee is said to have been annoyed by an almost open revolt by Subbarao last year against the setting up of a body headed by the finance minister to regulate disputes among regulators. Later, the RBI governor was also made a co-chairman of the body.

In the last two years, Prime Minister Manmohan Singh and Finance Minister Pranab Mukherjee may have been blamed for inadequate measures to contain inflation and corruption, but Subbarao has been widely hailed for his “heads on” approach to contain inflation.

His two-year extension was widely hailed by economists and the markets, and was considered a sign of the prime minister’s faith in a person who served under him. Analysts say the finance minister has virtually handed over the task of containing inflation to him. And he is trying his best.