The
Reserve Bank of India has made the right move by balancing growth with price
stability, rather than pursuing only growth at the risk of inflation getting
out of control. The central bank has very aptly recognised both the supply
side and demand pull pressures working the inflation up and has consequently
chosen to move early and raise the reverse repo rate by a quarter of a percentage
point to five per cent.
The bond markets did not expect a rate hike, perhaps in the wake of softer
global data pointing towards a pause in the global interest rate tightening
cycle and also because headline inflation numbers looked benign. However,
the devil is often in the details - one such detail being that oil price hikes
have not yet been passed on to the domestic consumer. Moreover,
at the current level, inflation might appear muted and is likely to get a
cushion from the high base of last year. Another caveat worth noting is that
the core wholesale price inflation (excluding the volatile food and energy
components) is starting to creep up again and the latest figures reveal that
this core reading is currently at 5.18 per cent - the highest since December
of 2004. Aside from that, inflation is not only supply-driven but as our output
gap suggests, demand-pull inflationary pressures are also starting to build
up in the economy.
With regard to the international economy, there is no denying the fact that
global pressures are intensifying. The US Federal Reserve has raised interest
rates eight times in the past 10 months and the Fed fund futures see the Fed
target rate close to 4 per cent by the end of this year. While Alan Greenspan
has reiterated that monetary accommodation will continue to be removed at
a 'measured' pace, the Fed seems to be taking greater cognisance of inflationary
risk building up in the US economy. This is evident from the omission of the
previous reference to the lack of increase of energy prices reflecting in
core inflation. With worldwide interest rate pressures building up, the RBI
has done well to move in tandem with the global economy. On balance, we believe
that the policy statements seem to be in line with the current macro-economic
dynamics.
In the interim, we believe that the elimination of uncertainty would provide
stability to the bond markets. Having said that, the interest rate environment
remains adverse and opportunities from the "buy" side are likely
to remain short-lived in a market that has to deal with the government's large
debt supply, apart from the liquidity demands being driven by the industry.
Overall, the policy is forward looking from the perspective of developing
the foreign exchange, fixed income and derivatives businesses. While T+1 settlements
will help balance sheet managers in more effective liquidity management, freeing
cancellations of contracts would provide more flexibility to the corporate
treasurer in managing his currency risks better. Besides,
there is talk of providing 'primary dealers' exclusivity in relation to government
bond auctions, which would give them the much desired competitive edge. There
is also a proposal to consider permitting corporate customers to write "covered
calls" which is likely to aid clients in improving their hedge economics.
The decision to consider "limited short selling" is a welcome, although
a long-awaited step. The
proposal of consolidation of debt securities, aimed at building up liquidity,
is also a positive move. Another remarkable initiative taken by the Reserve
Bank of India is that of 'communicating with the market' more often on the
monetary policy stance as part of global best practices quarterly reviews
of the credit policy would ensure a more structured interaction with the markets,
thereby enabling a more efficient response in the fast changing global monetary
dynamics.
Lastly, we see marginal impact on borrowing and lending rates of major banks
as the longer term interest rate benchmark is still steady
at six per cent and bulk of the banking system is not borrowing from the central
bank. Largely, it should be status quo for banks and businesses, going forward. *The
author is president, financial markets, Yes Bank
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