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Ahead of Policy, RBI Says Growth Subdued, Inflation Might Be Checked


The Macroeconomic Policy for Q3 will be tomorrow, but before that we have a statement by the RBI, which has interesting ramifications for what will happen tomorrow.

Here’s a list of points:

  • Growth is slowing. Corporate profits are down for two quarters in a row, and top line growth was just 2.5% higher than the previous year.
  • This has resulted in a slowdown in tax revenues, and with expenditures being high, we’re already at 87% of the deficit for the full year.
  • 3
  • Fuel subsidies are likely to shoot up as the diesel under recoveries are over Rs. 10 per liter.
  • Gold Imports have fallen substantially in the last few months.
  • 2
  • Corporates replaced their market borrowings (Commercial paper etc) with bank borrowings:

Non-food credit growth increased from 14.0 per cent y-o-y on July 12, 2013 to 17.9 per cent on October 4, 2013, markedly higher than the indicative trajectory of 15 per cent. In part, this trend was supported by corporate firms substituting their market borrowings, especially through CPs, by bank borrowings (Table IV.2). This substitution occurred as money market rates, including discount rates on CPs firmed up and primary market conditions remained subdued.

This is because Commercial Paper rates went through the roof.

  • Housing prices seem to have subsided (data will have to wait till tomorrow) to 0.89% growth q-o-q.
  • The NSEL crisis has “exposed regulatory gaps in systemic institutions”, says the RBI. Brokers active in multiple exchanges including NSEL will see a cascading impact of a default.
  • While Inflation might come under control soon (due to a good monsoon, they hope) the secondary impact of persistent inflation is still heating up the system.

What Will Rajan Do?

The last time, I’d come close to guessing what he would do and noting what he did. You don’t ever get lucky twice, so I shouldn’t be trying it again, but I’m a sucker for punishment so here we go. First, see this statement:

Unlike countries which could go for quantitative easing to support growth on the back of deflation or very low inflation, India has faced markedly higher inflation even when compared to its emerging market peers in recent years. This makes it important to keep liquidity under check and the policy rate at a reasonable level to anchor inflation expectations, with a view to ensuring stable macro-financial conditions and positive real returns to savers.

Liquidity under check is simply not happening as the RBI prints rupees to buy all those FCNR deposits that are coming in. They have to absolutely increase rates, and inflation “expectations” aren’t being anchored in anything but “high”.

While most of the policy seems to have been about slowing growth and potentially controlled inflation – two risks they continuously talk about are – persistent second degree inflation (primary articles rose in the past, so manufactured goods will go up now) and a fear of the US taper.

Liquidity is going to go crazy, a concept not addressed recently. With the FCNR swap, the rupee swaps with OMCs being temporary and the dollar selling in the markets, the RBI has a confused situation of adding and removing primary currency into the system. But it does seem that Reserve Money growth is going up – to nearly 8% from the 4% to 6% we saw last year. This is scary because although the multiplier effect is not much in the US (as banks don’t lend their money out)

In that context, let’s also see that the operational rate is the MSF – which is at 9%. I believe what Rajan might do is:

  • Increase Repo to 7.75% or 8%
  • Keep MSF at 9%
  • There could be some CRR/SLR alterations, but nothing major.
  • Talk about unwinding the OMC swaps by December.

What I believe he should do, and will likely not do is:

  • Take Repo to 9% or higher with a stated goal to destroy inflation completely.
  • Remove MSF – why have all those many rates! MSF can be handled by “bid” auction.
  • Let repo auctions happen throughout the day all the way to 5:30 pm.
  • Try to move lending to small and medium enterprises (where growth really comes from) and reduce it from the large corporates (who currently have over 50% of all bank credit).
  • Remove the restrictions on forex market participation of FIIs and banks (in exchange traded futures and options)
  • Force banks to pass on interest rate hikes to their depositers and borrowers.

Let’s see then.


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