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Calibrating Economy

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Is the Reserve Bank of India going to ease the rates finally? The central bank in its mid-year policy in October had indicated that it might halt rise in interest rate if the inflationary situation does not worsen.

The inflation picture, however, remains mixed. Food inflation fell to a nearly four-year low of 4.35 per cent in the week ending December 3. But manufacturing inflation rose in November from the previous month, helping keep wholesale price index inflation above 9 per cent for the 12th straight month.

The best that investors can hope for from India's central bank on Friday are measures to improve market liquidity and an acknowledgement that economic conditions are worsening.

A new element injected in the equation is the tumbling rupee, which hit a record low on Thursday at 54.30 before central bank intervention pulled it back. The plunging rupee is putting pressure on import prices and complicating inflation management task. The rupee is down more than 18 per cent from its July peak.

"Quite clearly, weaker rupee is creating its own damage on the inflation front and on growth, (which) keeps the central bank that much further away from easing rates," said Shubhada Rao, economist at Yes Bank in Mumbai.

RBI is not expected to stick its neck out to defend the rupee, which hit a record low on Thursday and seem to be falling lower every day. Rate cuts appear out of the question as inflation remains above 9 per cent.

But finally RBI did take steps to curb the sliding rupee on Friday.  It imposed r estrictions with immediate effect on forward trading in the local currency by FIIs and traders and capped banks exposure to the forex market.

RBI also decided to withdraw the facility of re-booking forex contracts by companies and Foreign Institutional Investors (FIIs) and reduced across-the- board exposure limits of banks which are authorised to deal in the foreign currency.

Falling growth has been an equal if not bigger worry.

"Domestically, the struggle against inflation and tightening interest rate regime has contributed to lowering of growth in demand and investment. The slowdown in industrial growth is of particular concern as it impacts employment," Finance Minister Pranab Mukherjee said in New Delhi.

State Bank of India Chairman Pratip Chaudhuri had said on Wednesday that he did not expect the RBI to hike interest rate in its next policy.

"I don't think so because food inflation has come down significantly and steadily. RBI has said 7 per cent is the level they are targeting", he told the reporters.

Chaudhuri also said he does not expect RBI to slash the Cash Reserve Ratio (CRR) as it would be contradictory to the monetary stance of targeting inflation.

Hopes that a worsening growth outlook might push forward the central bank's move to begin easing monetary policy have run up against the uncertainty caused by the plunge in the rupee, which has caught policymakers off-guard.

Prime Minister's Economic Advisory Council (PMEAC) on Wednesday suggested that the Reserve Bank should continue to focus on controlling the rising prices.

Economic growth is important but RBI has responsibility to see that inflation comes down, PMEAC Chairman C Rangarajan said on the sidelines of Delhi Economics Conclave.

"According to latest (inflation) numbers, it is still above 9 per cent. Therefore, concerns regarding inflation cannot be taken away from the monetary authorities," he said.

ICRA Economist Aditi Nayar and Crisil Chief Economist D K Joshi said also do not expect any rate cut on Friday.

Nayar said RBI is likely to keep the rates unchanged because though food inflation has fallen, manufactured products inflation still remains at an elevated level of 7.7 per cent. Joshi said rates can expected to be reduced only in the first quarter of 2012.

Industry bodies like CII and Ficci have already called upon the RBI to cut rates for ensuring industrial revival.

According to Goldman Sachs, the negative growth in IIP numbers increases the probability of an early reserve requirement cut by RBI.

"Our current expectation remains that the RBI will continue to inject liquidity through open market operations, then cut the reserve requirement ratios of banks in January, followed by repo rate cuts in March, 2012. We continue to expect the RBI to cut policy rates by an above-consensus 150 bp in 2012," Goldman Sachs said in a report.

Poor Investor Sentiment
The fall in the rupee has exacerbated poor investor sentiment, with Indian stocks down nearly 23 per cent this year, and the market will be looking to RBI Governor Duvvuri Subbarao for reassurance, even if his options are limited given the need to fund a widening current account deficit.

The RBI steps in to smooth volatility but is otherwise officially agnostic about the rupee's level versus the dollar.

"They will not, obviously, target a rupee level, but how do they manage the concerns emanating from a weaker rupee? That will be the question," Rao said.

The central bank may also lay out more measures to ease tight market liquidity through open market operations (OMOs). In the past three weeks the RBI has injected more than 240 billion rupees ($4.5 billion) into the banking system through bond buybacks.

Local shares have been battered this year as surging inflation and interest rates dimmed the growth outlook for the economy and corporate earnings. The global economic uncertainty has also pushed investors away from risky assets.

Foreign funds are net sellers of Rs 1,629 crore of Indian shares this year until Tuesday, in sharp contrast to a record investment of more than Rs 157,470 crore in 2010.

The domestic economic gloom deepened on Wednesday as figures showed a record low rupee is adding to the Indian central bank's inflation headache and an adviser to the prime minister said there was little that could be done to check the rupee's slump.

Finance Minister Pranab Mukherjee said on Thursday India needed practical solutions to address its economic slowdown.

These are troubled times for Asia's third-largest economy.

Data showed on Monday that India's industrial output slumped more than 5 per cent in October from a year earlier, far worse than expected and the first drop in more than two years, with capital goods output down 25.5 percent.

Overall economic growth slowed to 6.9 per cent in the September quarter, its weakest in two years, and some economists expect India to struggle to reach 7 percent growth in the fiscal year that ends in March 2012. The government had been targeting 9 percent earlier this year.

India's central bank has been criticised for acting too late in taking the fight to inflation despite the series of rate increases since early 2010. In October, the RBI indicated its tightening may be coming to an end even though inflation remains well above its comfort zone.

While inflation prevents the RBI from becoming more accommodative to stimulate growth, lower-than-targeted tax receipts and a worsening fiscal outlook curtail the government's room to maneuver to prop up growth.

"Options for fiscal steps as well as monetary measures are increasingly limited," Finance Minister Pranab Mukherjee said on Thursday.

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