Credit Policy Analysis

The Reserve Bank of India announced its third quarter review of monetary policy. The bank raised the Cash Reserve Ratio (CRR) by 75 bps to 5.75% and left the key policy rates, repo and reverse repo unchanged. The hike in CRR was above the street expectation of a 50 bps hike and the market reacted in a knee jerk manner, however has recovered because of a stronger growth outlook.

Some of the key highlights form the policy documents are:

· The Indian monetary authority sounded very bullish on growth in the third quarterly review of its annual monetary policy for FY10 and raised the growth projection for the economy to 7.5%, way ahead of its forecast of 6% with upside bias given in the last policy review three months ago

· The figure is also substantially higher compared with median forecast of 6.9% in the survey of professional forecasts release by the RBI on Thursday

· The deficient monsoon rainfall and drought conditions in several parts of the country have accentuated the pressure on food prices, pushing up the overall inflation rate – both of the WPI and consumer price indices (CPIs)

· The central bank says that even though a baseline scenario is comforting a number of downside risks to growth and upside risks to inflation are there

o There is still uncertainty about the pace and shape of global recovery and it is too dependent on public spending and will unravel if governments around the world withdraw their fiscal stimuli prematurely

o Expectations of softening domestic inflation are contingent on food prices moderating. This, in turn, depends significantly on the performance of the monsoon which if remains inadequate could continue to intensify inflationary pressures

o As growth accelerates and the output gap closes, excess liquidity, if allowed to persist, may exacerbate inflation expectation

Analysis:

The two-phased CRR hike will soak Rs 36000 crore from the banking system, that was the only negative that the RBI policy document. The way the banking and the real estate sector stock recovered clearly highlights the fact that the market has really taken this policy in a positive way, however one should remain cautious as there was nothing positive in the document which fundamentally could lead to a rally like today.

Credit Policy Eve

The Reserve Bank of India today released its review of the macroeconomic and

monetary developments which serves as a background to the Third Quarter review of

Monetary Policy 2009-10 being announced tomorrow, January 29th, 2010.

Some of the Key Highlights of the documents which we believe will set the tone of the

monetary policy are:

• The IMF, in its January 2010 update, has revised significantly the global growth outlook for 2010 (from the earlier projected 3.1 per cent to 3.9 per cent). Recovery in advanced economies is, however, expected to remain sluggish, while economic activity in emerging market economies (EMEs) and developing economies could expand vigorously, driven by domestic demand
• The pace and shape of recovery continue to remain uncertain. By far the biggest anxiety is about the recovery losing momentum once the props of fiscal stimulus and monetary accommodation are withdrawn
• Emerging economies, which are already on the recovery path, face various challenges from capital flows, potential inflationary pressures and credit revival
• According to the first advance estimates, production of kharif food grains and oilseeds is expected to decline by about 16 per cent over the previous year
• Corporate performance data up to the second quarter of 2009-10 indicate that despite the persistence of dampened (y-on-y) growth in sales, sequential quarterly growth remained positive. In the third quarter of 2009-10, partial data indicate significant (Y-o-Y) growth in sales.
• Pattern of capital flows, pace of the recovery in demand for credit from the private sector and the fiscal stance would influence the monetary and liquidity conditions in the near term
• Inflation emerged as a major concern during the third quarter, dominated by significant supply factors.
• In December 2009, there have been signs of emergence of generalized inflation
• While anchoring inflation expectations becomes important in such a situation, addressing supply constraints would be critical for enhancing the effectiveness of any anti-inflationary policy measures
• In view of the dominance of food price inflation, balancing the policy needs of supporting durable return to the high growth path while avoiding a situation of generalized increase in inflation through monetary policy actions has emerged as a delicate challenge for the Reserve Bank
• The upside prospects for further acceleration in growth in the near term derive support from several factors, including as per the Reserve Bank’s business expectations survey as well as similar surveys of other agencies
• According to the Reserve Bank’s Professional Forecasters Survey conducted in December 2009, the outlook for 2009-10 growth has been revised upwards from 6.0 per cent to 6.9 per cent
• The outlook for inflation will be conditioned by the upside risks in terms of persistence of supply side pressures in the near term and possible return of purchasing power because of higher growth
• The growth and inflation mix for India is increasingly becoming asymmetric vis-à-vis the pattern in other G-20 countries. The possibility of surges in capital inflows and the associated domestic liquidity conditions may also affect inflationary expectations, besides the impact of the rebound in international commodity prices in response to global recovery
• With a stronger recovery in India, the risk of food price inflation causing generalized inflation cannot be ignored

Analysis:

The RBI review clearly highlights the fact that the growth is no more a concern and is on apositive trajectory, however clearly states inflation as a big concern. Thus we believe that tocurb this inflation demon RBI may go against the general street consensus and increase the key repo and reverse repo rate by around 50 bps. (The CRR hike of at least 50 bps is almost inevitable).

In the last policy too, RBI did removed some unconventional measures and tightened prudential norms and said that “This is the beginning of the phase of monetary reversal”.

Thus we strongly believe that this quarter a reversal is highly likely on the cards and one should avoid investment (can go short) in rate sensitive sectors like Banking, Real Estate, Automobile and Capital Goods and move towards defensives like FMCG and Pharma (long).