Rate Hike Likely in Q3 RBI Policy

IMF Yesterday in a statement said that the RBI must increase its key policy rates in order to control inflation which is rising beyond its control. The food price inflation released yesterday was at its year high of around 18.3% and way above RBI’s comfort zone.

Thus I strongly believe that in its Q3 policy review RBI is most likely to increase its key rates to tame the inflation which would be negative for the banking and real estate sector in particular and overall markets in general because of an increase cost of funds.

Moreover, most of the banks are also increasing their deposit rates which will lead to a higher base rate and eventually a higher borrowing costs for India Inc. leading to a hurt in their bottom line.

The rising crude and commodity prices (especially copper) are already hurting the profits which with increase in borrowing costs will make things only worse.

Any new long position in the markets if taken should be after 14^th or 15^th of February to join the budget expectation rally, till then chances of a near term upside remains extremely unlikely, however one can take short positions in Nifty with a stop loss above 6050 with a target of around 5700.

ECB in 2008 = RBI in 2010 ?

I am sure that the subject of my article would be very confusing for some of you or may be strange for a lot of you. What I am trying to convey with this one is again some graduation level economics which I studied during my Macroeconomics paper in 2005, which I believe the world central bank's heads are forgetting or trying to overlook over more complex understandings.

The core objective of any Central Bank is to do a through analysis of the forthcoming economic situation of an economy (growth and inflation) and accordingly adjust the liquidity flow into the system. It also involves taking into account any major local or global events that could shape up the economic situation in the country and hence being prepared for the same.

Thus, in nut shell I would say that the core objective of any monetary policy is to manage liquidity into the system so that the economy grows (with minimal inflation), but this decision should be based on ex-ante analysis and not ex-post analysis.

This precise mistake I believe ECB committed in July 2008. In July 2008, when the global credit crisis was almost about to reach its peak, the global growth outlook was bleak and most of the central bank's around the world were either growing through rate cuts or on the verge of doing so, ECB announced a rate hike of 25 bps, which as per experts is one of the many important reasons of the current EU turmoils. The move as said by Mr. Trichet was" mainly on account of "heightened concerns at the ECB about inflation in Europe".

The inflation which was just a temporary phenomenon in EU because of the high commodity prices, made ECB think beyond the US Sub-prime and Global credit crisis and took a rate hike decision, saying that "the crisis was one belonging to US and will not have impact on EU". Thus in October when the US crisis started spreading wide the EU was down of out because of the decision in July.

The same is what RBI has done on Friday, going by its ex-post and probably present rate hike analogy has gone ahead with a rate hike. Its done probably at a time when the Indian banking system is already crunched for liquidity because of 3G and BWA auctions, can have a long repercussion. The RBI also said like EU said in 2008 that "Inflation is a bigger concern than EU Crisis".

Thus going further, I strongly believe that if this EU crisis spreads more (which has high chances) Indian economic growth and more importantly the stock indices could see a blood bath.

The Indian markets as of now is quite insulated from the global turmoil, but like EU in 2008 this move by RBI on Friday could lay the foundation for a big Index correction.