Reddy does a Trichet; leaves rates unchanged

It was one of the most anticipated RBI meetings over the last few months and Y.V.Reddy disappointed the street with leaving Indian benchmark rates; repo rate at 7.75, reverse report rate 6% and CRR at 7.5% something which did not go well with the markets. If you look at the history of Indian monetary and economic policies they have never been devised for markets. Indian policies have always been formulated keeping in mind the aam aadmi (politics of aam aadmi) and his well being. So it was not surprising to see Reddy keeping the lending rate unchanged at this high level since past 10-month. May be that is the biggest difference between Indian economic managers and the ones in US.

RBI has for long been saying now may be close to 2 years that inflation and liquidity is their biggest concern and it will do all possible thing in its armoury to curb the inflationary devil. The question then remains that how long this can continue in India, will we go the same path the US went. Well the answer lies more on the structural differences of two economies. They both are completely different in their own ways. RBI has been deeply concerned about the rising commodity prices especially oil and other food items, money supply is still growing and the rate hikes seems to have minimal impact if any on it also the liquidity remains fairly strong.

My point is that it would be interesting to see that when growth risks would over take inflationary risk and RBI goes ahead and cuts its benchmark rates. Well looking at the figures released by RBI it seems that growth is starting to moderate. This can be clearly seen in the credit numbers and industrial production numbers released the RBI and Finance Ministry respectively. Bank Credit has moderated to 22% (below RBI target of 24%) in 2007 from 28% and 32% in 2006 and 2005 respectively. Personal loans are down to 20% from 35% in 2006.

Since M3 growth, inflation and liquidity overhang are RBI concerns it should have at least announced a CRR hike and should have laid some more stringent guidelines on Capital flows into the country or else opt for MSS rather. The reason I feel so is that if Fed would go ahead and cut interest rates today by at least 25 bps the differential rate between India and the US would increase to 450 bps this would further lead to foreign exchange flowing into the country and excess liquidity and then RBI would have another issue at hand and that would be the soaring rupee, which already damage our export performance. The high rate differential would also induce Indian corporate to raise money through the ECB route. I guess it would not be wrong to say that RBI is today facing problem of plenty. It wouldn’t be a bad option if RBI can roll out a few infrastructure bonds and it would play a duel role one suck liquidity and the other been would also help in fulfilling infrastructure requirement (the greatest bottleneck in the economic growth story) of the country. I think RBI is too much concerened about inflation but it is missing one point that even if the government passes the rise in crude prices to the public inflation would still be under 5% comfort level of RBI. I completely agree with the concern about money supply and liquitdity and as mentioned above there are enough weapons in RBI’s armoury to suck liquidity.
A lot has been written about the slowdown in India and how insulated it is. But what is interesting to see is that India’s growth story is about domestic consumption and strong capital expenditure and sound balance sheets of Indian banks when you look in context of subprime fracas. I think somewhere the whole rate hike is starting to hurt the Indian consumer and his confidence. If that happens it would be difficult for the economic managers to get things back on track. Obviously it would be not as severe as it has been in the US. The rates have very likely peaked and a cut is very much on the cards in its next RBI meeting. According to me we are likely to see some rise in NPA’s especially the small loans segment where it is always risky and the risk of NPA’s is quiet high.

Indian economy despite all this could spring surprise by just managing to grow at 9% in 2007 and the big driver would be agriculture. I feel this year has been good for agriculture in the country. The sowing was on time coupled with good monsoon and increase in acreage levels in few important crops. Agriculture would grow above 3% and to me the agriculture scenario is likely to improve going forward. May be this time Bharat is likely to be the saviour of India. I would be keenly awaiting the CSO numbers on the GDP to be released next week and may be then we could revisit the numbers and economic scenario again.


(The views expressed in this blog is personal and not necessarily of my company)