RBI’s Mid-Quarter Monetary Policy Review

16th December 2010

CORPORATE ECONOMICS CELL

 Policy synopsis
• Reserve Bank of India (RBI) has kept the
repo, reverse repo and cash reserve ratio constant.
Statutory Liquidity Ratio (SLR) reduced from 25% of
banks’ net demand and time liabilities to 24%. (freeing
Movement in Key Policy Rates (%) up roughly Rs 510 bn)
Eff since Reverse Repo Repo CRR
5-Jan-09 4.00 5.50 5.50 • Will conduct open market operations which will
17-Jan-09 4.00 5.50 5.00 inject Rs 480 bn liquidity in the next one month.
4-Mar-09 3.50 5.00 5.00
21-Apr-09 3.25 4.75 5.00 • RBI has added an upward risk to its projection of
28-Jul-09 3.25 4.75 5.00 5.5% (y/y) inflation (WPI) by Mar11. The growth
27-Oct -09 3.25 4.75 5.00 projection of 8.5% for FY11 remains unchanged.
29-Jan-10 3.25 4.75 5.75
19-Mar-10 3.50 5.00 5.75 Opinion: The RBI has clearly indicated that the current
20-Apr-10 3.75 5.25 6.00 liquidity tightness is beyond its comfort level. The planned
2-Jul-10 4.00 5.50 6.00 increase in liquidity from the above measures is around
27-Jul-10 4.50 5.75 6.00 Rs 1000 bn which is close to the current average liquidity deficit
16-Sep-10 5.00 6.00 6.00 in the market. Note that the reduction in SLR is a permanent
2-Nov-10 5.25 6.25 6.00 measure; which possibly underlines RBI’s acknowledgement of
16-Dec-10 5.25 6.25 6.00 the current liquidity deficit being a structural rather than
episodic problem. These measures will definitely ease pressure on
interest rates, especially the short term rates. RBI’s concern over
inflationary pressure indicates that a subsequent rate hikes by
end-FY11 may be possible.
Aspects of RBI’s decision

LIQUIDITY GROWTH

INFLATION

(Click to choose or simply scroll down)

LIQUIDITY

BACK
 Tight liquidity conditions
1500 Gsec Yield (%)
Net LAF amount (Rs bn) 8.5

1000 8.0
7.5
500 7.0
6.5
0
Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 6.0
-500 5.5
10 yr gsec 1 yr gsec
5.0
-1000
4.5
-1500 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10

Call vs Repo vs Reverse Repo rate • Liquidity has been tight since Jun10. Average
8.5 injection of liquidity by the RBI in the past
Call Rate
7.5 Repo
month has been around Rs 1000 bn. The 1 year
Reverse Repo Gsec yield has increased by over 200 bps from
6.5
Apr-Dec10 in response.
5.5
• The RBI has indicated that it intends to ‘stabilise
4.5
interest rates in the overnight inter-bank market closer to
3.5 the operative policy rate’. As the graph on the left
2.5 indicates; since Sep10, the short term call rate has
1.5
unconventionally out of the window between
Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 repo and reverse repo rates.
BACK
 Structural liquidity deficit?

Credit vs Deposit growth rates (% y/y) 22

Currency with public (% y/y)
26
Non-food credit offtake
24 Deposit 20
22
18
20
18
16
16
14 14
12
12
10
Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10
Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10

• The RBI maintained that the tightness of liquidity is owing to persistence of large government cash
balances which have averaged Rs 840 bn since the Q2 monetary policy review (2nd Nov 2010). This is
primarily owing to the government already receiving 63% of budgeted revenue receipt in Apr-Oct
2010 as against 47% achieved in the corresponding period of the previous year..
• However the Reserve Bank is also worried about structural factors influencing liquidity. As the
graphs above show; deposits growth is not able to match credit growth. Additionally currency with the
public has registered sharp rise. The above-trend currency expansion and relatively sluggish deposit
growth rate will contribute to persistent liquidity crunch in the system.
BACK
GROWTH

BACK
 Strong growth performance
GDP (% y/y) [Left] Private consumption (% y/y)
IIP (% y/y) 6-month MA 10 Investment (% y/y) 19
24

Industrial 9
Growth
14
19
Production Dynamics
8 9
14

7 4
9

4 6 -1

-1 5 -6
Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Mar-08 Jul-08 Nov-08 Mar-09 Jul-09 Nov-09 Mar-10 Jul-10

• In Apr-Oct10, Index of Industrial Production (IIP) has grown by an impressive 10.3% (y/y). The
industrial production in Oct grew at a surprisingly high 10.8%. However the 6-month moving average
is showing decline (given that the original series is relatively volatile)
• The RBI opines that various indicators of industrial activity including the Purchasing Managers’
Index (PMI) suggest strong underlying momentum. Lead indicators of services sector activity have
continued to increase at robust pace.
• GDP grew by a healthy 8.9% in Q3 FY10, same as the previous quarter. While investment levels
have moderated from 19% in Q2 to 11.5% in Q3; private consumption continued to rise. The RBI
maintains its optimism for growth, and forecasts 8.5% GDP growth by FY11.
BACK
 RBI’s industry outlook survey:
Jul-Sep 2010
Overall Business Situation Demand Outlook
Overall Business Situation (current quarter) 40 50
60 Order Books (current quarter)
Overall Business Situation (next quarter) 45
Order Books (next quarter) [Right]
50 30
40
40 35
20
30 30
20 10 25
20
10
0
15
0 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10
10
Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 -10
-10
5
-20 -20 0

Financial Situation outlook • Overall business sentiment remained

50 strong for the next quarter (Q4 FY10)
40
among the manufacturing companies
participating in RBI’s latest industrial outlook
30
survey. Demand outlook, quantified by order
20 books also remains robust.
10
Financial Situation (current quarter) • While RBI’s hawkish monetary policy had
Financial Situation (next quarter)
0 dampened the Financial Situation outlook
-10
Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10
for companies; there is an uptick recorded
for Q4 (left)
-20
BACK
INFLATION

BACK
 Inflationary pressures exist
WPI (% y/y) Break-up of WPI
12 Fuel Primary Manufactured (right)
25 10
10 20
8
8 15
6
6 10
5 4
4
0
2
2 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10
-5
0 0
-10
Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10
-2 -15 -2

•Inflation declined to 7.5% in Nov10 compared to 8.6% in the previous month. This has been the first
time in the past ten months that WPI has dipped below 8%; primarily owing to base effect. While Food
price inflation has moderated from an average of 15.7% in Q1 FY11 to 12.3% in Q2, to 6.1% in Nov10;
inflation is still being driven by protein items, suggesting a structural shift in consumption patterns. In
addition, non-food inflation primary inflation is strengthening.
• RBI’s Industrial Outlook survey in Q3 2010 reveals that most manufacturing companies have reported
hardening of input and selling prices in the current and forthcoming quarters. This will put further
pressure on manufacturing inflation.
• RBI’s household inflation survey suggests firming of inflationary expectations for the next quarter and
year. The RBI cites increasing domestic demand and high global commodity prices as potential inflationary
risks. It maintains WPI forecast of 5.5% by Mar11, with the addition of an upward bias.
 Thank You

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