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Institutional Research

Policy Review

Policy Review
Economist Siddhartha Bhotika Email: siddhartha.bhotika@tatacapital.com 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

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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

Tata Securities Limited


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Analyst Certification: I, Siddhartha Bhotika, the research analyst and author of this report, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities, issuers, products, sectors or industries. It is also certified that no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst(s), principally responsible for the preparation of this research report, receives compensation based on overall revenues of the company (Tata Securities Limited, hereinafter referred to as TSL) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. Disclaimer This report is for the personal information of the authorized recipient and does not construe to be any investment, legal or taxation advice to you. TSL is not soliciting any action based upon it. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any such transaction. In preparing this research, we did not take into account the investment objectives, financial situation and particular needs of the reader. This research has been prepared for the general use of the clients of the TSL and must not be copied, either in whole or in part, or distributed or redistributed to any other person in any form. If you are not the intended recipient you must not use or disclose the information in this research in any way. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. TSL will not treat recipients as customers by virtue of their receiving this report. Neither this document nor any copy of it may be taken or transmitted into the United States (to US Persons), Canada or Japan or distributed, directly or indirectly, in the United States or Canada or distributed, or redistributed in Japan to any residents thereof. The distribution of this document in other jurisdictions may be restricted by the law applicable in the relevant jurisdictions and persons into whose possession this document comes should inform themselves about, and observe, any such restrictions. It is confirmed that Mr. Siddhartha Bhotika (MA, Economics), the author of this report have not received any compensation from the companies mentioned in the report in the preceding 12 months. Our research professionals are paid in part based on the profitability of TSL, which include earnings from other business. Neither TSL nor its directors, employees, agents or representatives shall be liable for any damages whether direct or indirect, incidental, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information contained in this report. The report is based upon information obtained from sources believed to be reliable, but we do not make any representation or warranty that it is accurate, complete or up to date and it should not be relied upon as such. We accept no obligation to correct or update the information or opinions in it. TSL or any of its affiliates or employees shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. TSL or any of its affiliates or employees do not provide, at any time, any express or implied warranty of any kind, regarding any matter pertaining to this report, including without limitation the implied warranties of merchantability, fitness for a particular purpose, and non-infringement. The recipients of this report should rely on their own investigations. TSL and/or its affiliates and/or employees may have interests/ positions, financial or otherwise in the securities related to the information contained in this report. To enhance transparency, TSL has incorporated a Disclosure of Interest Statement in this document. This should, however, not be treated as endorsement of the views expressed in the report. Disclosure of Interest Statement in Policy Review as on July 30, 2013 1. Name of the analysts: 2. Qualifications of the analysts: 3. Analysts ownership of any stock including the long & short position related to the information contained: 4. Ownership of any stock held by the dependent family members of the analyst including the long & short position: 5. TSL ownership of any stock related to the information contained including the long & short position: 6. Broking relationship with company covered: 7. Investment Banking relationship with company covered: Siddhartha Bhotika MA (Economics) NO NIL NIL NO NO

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30 July 2013