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Institutional Research

Policy Review

Policy Review
Economist Siddhartha Bhotika Email: Tel: +91 22 6606 9407

RBI maintains status quo

As expected, the first quarter monetary policy review turned out to be a nonevent for the market. The repo rate and CRR were left unchanged at 7.25% and 4% respectively, while the recent liquidity tightening measures to curb forex volatility were also maintained. However, the central bank struck a dovish note by clarifying that the overall easing stance would have been maintained, given the growth-inflation dynamics, if not for the necessity to rein in the Rupee depreciation. We believe these liquidity tightening measures could be rolled back by 2Q-end as some semblance of stability returns to the currency market. Thus, we maintain our view for further easing in the repo rate by 25-50bps by FY14-end. In the interim, the onus is on the authorities to chalk out a credible plan to combat the funding risk on the large current account deficit in the face of subdued portfolio flows. Growth outlook remains subdued Latest high frequency growth indicators such as IIP (-1.6% YoY in May), PMI (near four-year lows) and auto sales (~-2% YoY for 1QFY14) continue to point towards subdued momentum, while a significant recovery in investment demand remains distant in the absence of much-needed structural reforms. With shortterm interest rates rising above 10.25%, the borrowing cost for an average Indian corporate has increased by 200-400bps, which is likely to crimp the overall economic activity further in the short term. We, therefore, have cut our FY14 growth estimate to 5.4% (from 5.9% earlier). The central bank has also pared its growth projection by 20bps to 5.5%. Government spending is high in pre-election years
30 25 20 15 10 5 0 1996 1998 1999 2004 2009 2014*

Average growth in the preceding period Source: CEIC, Tata Securities Research. * 2014 numbers are budget estimates

Growth in the run-up year

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Policy Review

Investment environment remains inconducive

Factor Policy clarity Short term rate outlook Long term rate outlook Stable inflation outlook Profit margins Leverage Capacity utilisation Continuity of Govt policy Overall Source: Tata Securities Research Amenable No Yes Yes No No No No No No Mildly positive on improved inflation outlook Mildly positive on improved inflation outlook Inflation has generally surprised on the upside in the past, structural issues remain unaddressed Industry profit cycles are close to bottoming out, not attractive for new entrants Leverage, in general, has been high Near crisis lows, as per latest surveys by RBI Uncertain as general elections are due in 2014 Private investments need to be given a strong incentive Remark Lack of clarity on land acquisition, input linkages, mining bans etc

Our growth assessment is based upon expectations of higher consumption demand owing to improved agricultural output and high government spending in a pre-election year. We do not expect any meaningful recovery in investment demand due to uncertain policy outlook and lack of decisive action on execution uncertainties (land acquisition, input linkages) and necessary regulatory clearances. Initial reports on the temporal and spatial distribution of monsoon have been promising. We will watch out for further cues on both agricultural output prospects and food inflation risks. Weak Rupee weighing on inflation outlook Even though the economic activity remains lacklustre, persistent high food inflation and weaker currency pose significant upside risks to inflation outlook. Food inflation is expected to remain at elevated levels on account of structural factors, despite an above average monsoon so far. In fact, there is now a reasonable chance of kharif crop production being negatively impacted to some extent due to excess rainfall. Moreover, the impact of the sharp currency depreciation since May would also begin to reflect in inflation numbers in the coming months. Core inflation could pick up again in coming months
10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Dec-08 Dec-09 Dec-10 Dec-11 Sep-08 Dec-12 Sep-09 Sep-10 Sep-11 Mar-09 Mar-10 Mar-11 Mar-12 Sep-12 Mar-13 Jun-13 (%) (%) 10.0 9.0 8.0 7.0 6.0 5.0 4.0

Core inflation

Repo rate -RHS

Source: CEIC, Tata Securities Research

30 July 2013

Policy Review

Liquidity tightening measures expected to be short-lived Similar measures have been previously undertaken by the RBI in 1998, 2000 and 2008 and remained in place for four-nine months. We expect the same this time around as well. An important point to note here is that this time around, the central bank has so far refrained from raising the traditional repo and CRR rates. Moreover, the central bank struck a dovish note by clarifying that the overall easing stance would have been maintained, given the growth-inflation dynamics, if not for the necessity to rein in the Rupee depreciation. The enhanced carry and liquidation of Dollar holdings of banks and corporates in lieu of the now more expensive Rupee liquidity should help stabilise the currency in the near term. We expect the Rupee to trade in the 57.50-60.50 range over the short to medium term. We also expect the RBI to intervene in case the higher end of the range is under threat. As such, we expect these measures to be rolled back by end of 2Q, once the Indian Rupee begins to stabilise and speculative bets against the currency are significantly scaled back. Outlook Given our expectations for the overall growth-inflation dynamics, we believe these liquidity tightening measures could be rolled back by 2Q-end as some semblance of stability returns to the currency market. Thus, we maintain our view for further easing in the repo rate by 25-50bps by FY14-end. In the interim, the onus is on the authorities to chalk out a credible plan to combat the funding risk on the large current account deficit in the face of subdued portfolio flows.

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Policy Review

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30 July 2013