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REVISION IN GDP FORECAST DEPICTS ECONOMIC STRENGTH

Thesynergyonline Economic Bureau

NEW DELHI, JULY 28 :
THE progress of monsoon though at 14 percent deficit, still better than previous year, strong IIP (double digit growth) suggesting increased economic activity and prevailing global macro economic scenario are the main thesis for the revision in baseline projection of real GDP growth for FY11E to 8.5 percent from 8 percent earlier , according to ICICIdirect analysis.

The headline inflation has remained in double digit for the last two months with non-food items contributing over 70 percent to WPI inflation in June 2010 (10.6 perecent) that warranted the rate hike.

The demand side inflation is rising due to excess liquidity, which was witnessed in the system for nearly 17 months till May 2010. In order to curb the same, the repo rate has been raised by 25 bps and reverse repo rate by 50 bps reducing the LAF corridor and, thereby, lowering volatility in short-term money market. However, we do believe interest rates at the shorter end of the curve will rise faster than longer end.

According to ICICIdirect, the 10 year G-Sec yields will stay within 7.6 percent to 8 percent for the next six-eight months. The yield will not decline much as of the borrowing plan of Rs 3,45,100 crore only Rs 1,32,900 crore (38.5 percent of the total programme) of borrowing has been done, so major part of the borrowing is still to be done .

The credit growth picked up in Q1FY10 with non-food credit growth at 22.3 percent (July 2, 2010) mainly boosted by one-off telecom sector loans. This resulted in LAF turning negative from last month. It is believedf that the RBI is going to maintain just adequate liquidity in the system and hence, RBI has gone for a higher reverse repo rate hike, which is, in effect, higher cost to RBI.

Since mid quarter policy review has been introduced for the first time, surprise rate hike or announcements from RBI is not expected, reducing vulnerability of sharp moves in G-sec yields or short term money market rates.

Banks will have to hike deposit rates in order to shore up deposit reserves as money becomes dearer in alternate markets. This will boost deposit growth which currently stands at 15.3 percent. With base rates coming into the picture, it is believed that deposit repricing will directly start having an impact on base rates and, thereby, lending rates. Also, the NIM should be maintained at current levels. We continue to remain overweight on the banking sector, particularly private sector banks, and cheaper midcap PSU banks. This is mainly on account of higher NPAs reported by major PSU banks. The same has not yet peaked, the analysis report says.

Liquidity turned in deficit mode after 17 months in May2010. The high liquidity prevailing in LAF corridor turned negative which can be attributed to 3G auction payments and advance tax out flow for Q1FY11.

RBI has guided that liquidity will remain just adequate to negative zone for rest of the year, suggesting upward bias for interest rates.(editor@thesynergyonline.com)

REPO RATE HIKED BY 25 BASIS POINTS TO 5.75% ; CRR UNCHANGED AT 6%

Thesynergyonline Economic Bureau

NEW DELHI, JULY 27 :
THE Reserve Bank of India (RBI) in its first quarter review of monetary policy for 2010-11 today hiked its repo rate by 25bp to 5.75 percent, as expected, but effected a more aggressive 50bp hike in the reverse repo rate to 4.5 percent (Consensus and Nomura: 25bp), reducing the width of the interest rate corridor from 150bp to 125bp.

The cash reserve ratio was left unchanged at 6 percent as expected because of persistent deficit liquidity situation. The narrowing of the corridor should reduce volatility in the overnight rate. It also became a necessity because of the shift in the RBI’s liquidity stance.

The RBI expects liquidity pressures to ease, but it is likely to remain tight. No additional liquidity easing measures were announced, suggesting that the RBI is taking the opportunity to use tight liquidity conditions to ensure a more effective transmission of policy rates to bank lending rates.

Short-term rates have increased by 150bp over the last two months and with the incremental credit-deposit ratio at more than 100 percent, hikes in deposit and lending rates can be expected to follow faster. The RBI’s objective is to ensure that liquidity “remains broadly in balance”, suggesting that the repo rate has now become the effective policy rate. Tight liquidity conditions could not have come at a better time for the RBI.

The inflation has become persistent and generalised, prompting a rise in the RBI’s WPI inflation projection for March 2011 to 6.0 percent y-o-y from 5.5 percent. The reading of the RBI’s WPI inflation fan chart is that inflation peaked in April and will trend lower; but it will remain in double-digits till September before falling to 7 percent by December and to 6 percent by March 2011. Meanwhile, the recovery has become more broadbased. The RBI revised up its GDP growth projection to 8.5 percent y-o-y in FY11 (year ending March 2011) from “8 percent with an upside bias” earlier, on expectation of stronger private consumption and investment.

Monetary policy decisions will now be taken eight times a year rather than quarterly, removing some of the surprise element of intermeeting decisions. The next policy meeting is scheduled on September 16 and it is expected that the RBI will further narrow the interest rate corridor by hiking its reverse repo rate by 50bp and the repo rate by 25bp.

Cumulatively, 50bp of hikes in the repo rate and 75bp in the reverse repo rate between now and March is expected. While rate hikes should continue due to higher core inflation , it is believed that the pace of moves will be tempered.

Tight liquidity should ensure a faster transmission effect of monetary conditions on the economy. Nomura’s composite leading index already suggests a moderation in non-agriculture GDP growth in 2H 2010 . Also, given WPI inflation has likely already peaked and with global commodity prices broadly stable, input cost pressures should ease. However, liquidity management in the short run will be challenging, in our view. With advance tax outflows in mid-September, even ensuring that liquidity remains broadly in balance will be difficult. (editor@thesynergyonline.com)

RBI EQUITABLY ADDRESSES ISSUE OF INFLATION , GROWTH

Dr Swati Piramal , ASSOCHAM president

THE Monetary measures announced by RBI equitably address concerns for reigning inflationary expectations and cooling demand pressures as also maintaining sustained growth momentum, according to The Associated Chambers of Commerce and Industry of India (ASSOCHAM).

Welcoming the monetary policy prescription of RBI, ASSOCHAM president, Dr. Swati Piramal , said that with the hike in reverse repo rate, general liquidity will be maintained in the system for sustained growth of over 8.5% with positive bias.

Depositors with banking system will have higher interest rates with increase in repo rate and their long standing demand will now be meted out with this decision of RBI. However, the lending rates may move north by 25-50 basis points, making bank's borrowings a little more dearer since repo rate and reverse repo rate have been hiked by 25 to 50 basis points, added Dr. Piramal.

RBI NOT NEGATIVE ON REAL ESTATE : RELIGARE CAPITAL MARKETS

THE RBI its First Quarter Review of the Economic Policy has not sounded as negative on real estate while commenting on the generalised nature of inflation and the need to anchor the inflation expectations. While the RBI has noted that a sustained and rapid rise in housing prices over successive quarters remains an area of concern from spill over into general economy, the relatively moderate growth in Q4FY10 (as noted by RBI) and evidence that Q1FY11 prices are actually lower, and moderate growth in real estate loans (decline since Sep’09) are likely to stop the RBI from taking direct adverse steps at the sector.

Our expectation of rate increases (50bps), recent stock performance and likely weak results, though, should mute stock performance in short term. Market should turn its focus back on growth soon, and with little valuation support in the large caps, our top picks are Phoenix (PHNX), Puravankara (PVKP) and Anantraj Industries (ARCP).

Housing prices exhibit moderate growth in Q4FY10: As per the RBI, a sustained and rapid rise in housing prices over successive quarters remains an area of concern from the standpoint of its possible spill-over to demand pressures, the general price level and financial stability. But the RBI also notes that the rate of increase in Q4 was moderate, except in Delhi where prices have risen with a lag. Housing price indices show prices in Bangaluru have declined marginally while those in Mumbai and in Delhi are up 36 percent y-o-y.

This was normally within the range of our sample checks, barring Bangaluru where we have seen a slight price rise as against a decline noted by the RBI in its review. The housing contribution to y-o-y price inflation has been almost 5 percentage points of the 13-14 percent CPI headline numbers.

Real estate loans also see moderate growth: Housing loans grew 9.6 [per cent y-o-y (5.7 percent last year) during April – May’10 while real estate loans grew only 1.5 percent y-o-y (vs. 54.9 percent ( last year).

Within the services sector, credit to real estate decelerated sharply, reflecting definitional change to the concept of “lending to real estate sector” effected in September 2009.

Affordability not hit by 100bps interest rate hike, but property price increase capped by 10 percent y-o - y

Our Affordability index suggests that a 100bps rise in interest rates may get absorbed by the expected income growth. However, the rate hike coupled with a price rise of 10 percent may worsen the affordability metric for the home buyers, thereby dampening volumes.

Near-term headwinds likely; long-term volumes story hinges on (moderate) prices: The leading real estate stocks are up anywhere between 15-26 percent in the past two months.

Given the expected hike in key policy rates and likely weak results, stocks could correct in the short-term. However, we believe that volumes in H2CY10 should be higher than in H1CY10, which could support stock prices. Valuations do not provide support to many large-caps. Our top picks are mainly mid-caps such as PHNX, PVKP and ARCP.

FOCUS ON STABILITY TO SUPPORT SUSTAINABLE LONG-TERM GROWTH

Chanda Kochhar, MD and CEO, ICICI Bank

THE Reserve Bank of India’s first quarter review of monetary policy for fiscal 2011 has endorsed the strong growth fundamentals of the Indian economy. The GDP growth projection for fiscal 2011 has been raised to 8.5 percent, despite the continuing uncertainties in the global economy. This indicates RBI’s confidence in India’s domestic fundamentals, and the relative ease with which India has weathered the global economic storm.

With confidence in growth firmly in place, RBI has focused on the price stability objective. While taking cognizance of some moderation in inflation in recent months and the potential positive impact of a normal monsoon, RBI has taken steps to address the increasing generalization of inflation across food and non-food items. The monetary measures announced are a continuation of the normalization of policy rates that RBI has been bringing about over the past few months, and are broadly in line with market expectations.

At the same time, RBI has left the cash reserve ratio unchanged. This would ensure that the system has adequate liquidity, and is in consonance with measures adopted by RBI in the recent past to enhance systemic liquidity in anticipation of advance tax payouts and telecom auction-related outflows. This approach, along with the narrowing of the LAF corridor in this policy review, would serve to maintain stability in financial markets even as monetary policy in general is tightened to normalize policy rates and contain inflation. RBI’s move to increase the frequency of public statements on policy review is also welcome, and would enable the market to understand RBI’s thinking on a more frequent basis.

In sum, the policy stance is in alignment with a growing economy that is experiencing inflation concerns, some of which can be addressed only through structural improvements over the medium-to-long term. It will maintain financial stability that will provide a basis for sustainable growth over the long-term.

REPO RATE HIKE WILL LEAD TO LENDING AT HIGHER RATES

Babulal Varma, MD, Omkar Realtors

THE hike has come at a time when the realty sector has managed to find its feet after going through turbulent times during the recession last year. The rates have already gone up 75 basis points, since February 2010. The credit scenario has tightened for the sector along with rise in commodity and land prices. A further hike will lead to lending to real estate companies at even higher rates. This could lead to margins being put under pressure & being an impediment to the growth of the real estate industry. However, if these policy changes can curb the inflation rates & the rate of commodities can be kept at a reasonable level, then it can be beneficial to the industry in the long run.

From the consumer’s perspective, a small 25 base point leads to a fair increase to his home loan outflow & also may lead to withdrawal of the teaser home loan from the market. This will create a huge impact to the demand for the small/compact home segment.

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