Intelligentguess

The Reserve Bank of India has released the “Report on Currency and Finance” for the year 2005 - 2006 today.  This is an annual report and is traditionally released with a delay of about a year or so, though it does discuss recent developments in the financial markets and policy formulation too.

The report can be found here.

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Situation

• On a monthly basis orders grew by 2.90%   ( -0.59 % drop in Feb’07)
• On a yearly basis orders grew by 10.21 % p.a ( 5.94% p.a growth in Feb’07)

Background

• Interest rates have been raised in Dec’06 towards 3.5% and in Mar’07 towards 3.75%.
• Members of the ECB have said that interest rates would again be be increased in Jun’07
• Orders have been declining since the interest rate hike in Dec’06

Conclusion

1. The orders growth can be expected to range between 4.5 % p.a to 9.5 % p.a initially ( Mid ‘07 )
2. Post this - growth looks like droping to a “0% ” after Mid ‘07 towards mid ‘08

Related links

• Europe - New Orders growth rate drops in Feb 2007
• USA - New Orders declines in Mar’07
• Japan - Dramatic fall in new orders in Mar’07 ( strongest fall since May ‘02 )

• Euro area - Production (IIP) grows in Feb’07
• Japan - Production growth rate drops in Mar’07
• USA - Production grows in Mar’07 at the slowest pace since Sept’05
• UK - Production - annual growth rate slips to a negative in Mar’07
• India - Production grows in Mar’07

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The Reserve Bank of India (RBI) seems to have changed tactics in the conduct of its monetary policy. There is a distinct shift in focus that is quite evident if one analyses the events of the last week or so.

Let’s recall what’s happened in this time

• The Indian rupee (INR) hit a 9 year high (breaching 40.50 to the US dollar on Tuesday) only to retrace sharply to close at 40.85 on Wednesday.
• Overnight money rates (in the collateralized segment) hit new lows with several deals being struck at 0.10% p.a. levels (Reminds me of Japanese interest rates)
• Overnight money rates have fallen sharply on the back of a liquidity infusion of INR 200 bn on account of the maturity of a government bond. In spite of being aware of this, the RBI opted not to conduct an open market sale of security under the market stabilization scheme (MSS).

To most marketmen, the fact that RBI would take measures to sterilize the large liquidity infusion was an almost foregone conclusion. The absence of an MSS issuance meant that the marketplace is now contemplating a hike in the Cash Reserve Ratio (CRR).

In my view, however, an immediate hike in the CRR is probably unnecessary, clearly unjustified and unlikely to be resorted to in the near future. We should remember that CRR is a blunt instrument which has a systemwide impact in equal measure. It does not differentiate between the big and small, the liquidity surplus or liquidity deficit entities. Further it pays no return whatsoever on the impounded cash, and thus has an adverse impact on banks’ finances.

Why, then, has the central bank allowed the surfeit of liquidity to continue and allowed overnight rates to hug near zero levels. The answer probably lies in the shifting focus of the monetary authority.

While liquidity and interest rate management had received priority in recent times (ostensibly to rein in runaway inflationary expectations), it appears that the focus has now tilted appreciably towards exchange rate management.

By allowing the surfeit of rupee funds to perpetuate in the system, the central bank has eased the pressure on the appreciating rupee, thus partly achieving its objective of managing exchange rate to promote export competitiveness. The voices from the export community had become shriller almost every day, and the central bank seems to have decided to listen to them.

This also signifies that the RBI in general and the Governor Mr. Reddy in particular seem to believe that inflation (or at least that part of inflation that monetary policy can influence) is not so much of a concern now. Some of Mr. Reddy’s recent comments seem to echo this view in a way. He has been making soothing noises on the inflation front - about how inflation volatility is coming down et al.

While it is clear that RBI has changed tactics, what interests me most is to see how long would they persist with this. It wouldn’t surprise me a bit if they change focus again within the next few weeks or even days. Hasn’t that been the hallmark of the conduct of monetary policy in the last few months?  

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Credit rating agency Fitch, today, downgraded bonds issued by ITI Limited, a (sick) Government of India owned telecom equipment manufacturer to default grade “D (Ind) (SO)”.

This, in itself, may not be much newsworthy, except for the fact that these bonds carried the highest possible rating “AAA (Ind) (SO)” prior to this downgrade to default category. The AAA rating had been assigned on the basis of an unconditional irrevocable guarantee given by the Government of India.

It appears that a few investors had opted to exercise their put option. These included a large (politically connected) residuary non banking finance company, a bank and a provident fund. However, there seems to be an inordinate delay in the repayment of principal leading to the downgrade by the rating agency.

This leads us to the question;

• Isn’t an unconditional, irrevocable guarantee as good as an obligation of the Government? Especially, since the defaulting entity is also owned by the government.

To my mind this is as good as a default by the government on debt denominated in (believe it or not) domestic currency. And this is a government which is proudly of its fiscal record.

Frankly, this is not the first time that the government has displayed such disregard for its contractual commitments to investors. We’ve had such instances in the past too.

Which leads me to another closely related issue;

Provident Funds are effectively forced to invest in such bonds, due to the statutory investment pattern. The statutory investment pattern is supposedly devised to eliminate such risks of default. On the contrary, provident funds have piled themselves with such and similar other junk debt. It’s another time bomb waiting to explode.

High time, our communist buddies understand and appreciate market realities and help in bringing about pension reform. Till such time, we are doomed with our retirement funds  invested in such junk investments.

Update (May 25, 10 AM India Time) : The Times of India has some additional details. It appears that Canara Bank, the trustee to the bonds, have not invoked the guarantee. Now, that raises questions on trustee responsibility. Incidentally, Canara Bank is also owned by the Government.

It also appears that the folks at the Times of India read this blog. Notice the similarity in the language.

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The Indian Stock markets traded weak on Wednesday, May 23. The weakness was led by banking sector stocks.

These stocks were weak on rumors floating around in the marketplace that the Reserve Bank of India (RBI) may hike the cash reserve ratio (CRR) – the proportion of deposits that commercial banks have to set aside as a statutory pre-emption. Banks do not earn any interest on these pre-empted funds.

The trigger for the story seems to be the large inflow (in excess of INR 200 bn) expected into the system due to the maturity of a government bond (11.90% - 2007).

Step back to a few weeks ago (I forget the exact date). Bank stocks were on fire (with most of them gaining by as much as 5% on that day). And the story that led to that move was that the RBI was contemplating a cut in the CRR. Ironically, overnight money rates on that day were ridiculously low (less than 0.50% per annum). Precisely the kind of conditions that preclude any cut in the reserve ratio.

However, strange are the ways of the marketplace – the rumor was allowed to perpetuate for the whole day. By the evening, when it was pretty clear that a CRR reduction was never going to be in sight, the story promptly switched to a possible reduction in the statutory liquidity ratio (SLR) – the proportion of deposits that commercial banks have to compulsorily invest in government securities. The SLR story was more credible, I should add.

Coming back to present day moves, what puzzles me is how marketmen react to a piece of information (the upcoming bond redemption) that is known for ages. Weren’t markets supposed to discount all publicly available information (the efficient market hypothesis)? Or is it, that the stock markets are getting around to the RBI Governor Y V Reddy’s penchant for springing surprises.

A CRR cut when overnight money rates were ruling at Japanesque levels – that would have been the coup de grace!

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Situation

• On a monthly basis prices rose by 0.63 % (0.67 % in Mar’07)
• On an annual basis prices rose by  1.91 % p.a ( 1.94% p.a in Mar’07)

Core inflation stands at 2.08% p.a ( was 1.96% in Mar’07)

Background

• Growth in producer prices have been dropping since May’06    and prices in Mar’07 rose at its slowest pace since Jul’04
• While production growth has been sustained New Orders growth has been declining since the interest rate hike in Dec’06
• The European Commercial Bank (ECB) had raised its interest rates from 3.25% to 3.75%,  in Dec’06 (25 basis points), and in Marc’07 (25 basis points).

• The European Commercial bank ( ECB) aims at inflation ( CPI ) rates of below, but close to, 2% over the medium term. They have achieved this primary goal. Inflation growth has been on a downward trend since Jun’06
• However core inflation ( inflation excluding energy prices )  at 2.08% p.a has been a worrying factor ( click on image for a larger visual). It has been on a rising trend since Mar’06.
• Core inflation growth is at its highest levels since Jun’04
• As on May 16 ‘07 crude is averaging at 62.59 for the month. ( 2.2% less than Apr’07)

• Members of the ECB have suggested that they may consider raising interest rates in June’07

Conclusion ( click on images for a better visual)

Inflation looks like ranging below 2.00% towards 1.5% in coming 1-3 months

However given the fact that core inflation has had no drop ( and is on a rising trend) it does look likely that the ECB would raise interest rates in Jun’07

Related links

• Euro area - Inflation (CPI) flat in Mar’07
• USA - Inflation rate (CPI) drops marginally in Apr’07
• UK Inflation (CPI) drops in Apr’07
• Japan - Inflation indices ( CPI ) deflate in Mar’07 
• India - marginal drop in inflation ( CPI )

• Europe - Producer Prices : Prices in Mar’07 rise at the lowest pace since Jul’04
• USA - Producers prices remain high in Apr ‘07
• UK - PPI Producer prices drop in Apr’07
• Japan - Producer prices rise in Apr’07

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Situation

On a monthly basis production increased by 0.7 % in Apr’07 ( - 0.3 % decline in Mar’07)

On a yearly basis  increased by 1.9 % p.a in Apr’07 ( 2.1 % p.a decline in Mar’07)

Background

• USA - Production growth in Mar’07 was at its slowest pace since Sept’05
• New orders, Shipments and Inventories position seem to indicate that Production growth can drop further

Conclusion ( click on image for a larger visual) 

1. Production growth can be expected to range between 1.90% p.a and 4.2% p.a growth towards mid’07 .
2. Possibilities of drops below 1.90% exists thanks to the Orders,Shipments and Inventories position
3. This could be followed by a further drop down towards (- 5.0%) towards end of 2007 early 2008.

Related links

• USA - Q1 2007 GDP annual growth slumps to its lowest since 2003 Q3

• USA - Production grows in Mar’07 at the slowest pace since Sept’05
• Euro area - Production growth sustained in Mar’07
• Japan - Production growth rate drops in Mar’07
• UK - Production - annual growth rate slips to a negative in Mar’07
• India - Production grows in Mar’07

• USA - New Orders declines in Mar’07
• Europe - New Orders growth rate drops in Feb 2007
• Japan - Dramatic fall in new orders in Mar’07 ( strongest fall since May ‘02 )

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Situation

• On a monthly basis production grew by 0.44%   ( 0.47% growth in Feb’07)
• On a yearly basis production grew by 3.80% p.a ( 4.02% p.a growth in Feb’07)

Background

• Interest rates have been raised in Dec’06 towards 3.5% and in Mar’07 towards 3.75%.
• Members of the ECB have said that interest rates would again be be increased in Jun’07
• Orders have been declining since the interest rate hike in Dec’06

Conclusion 

1. Initial movement between a low of 2.2% p.a upto a upside of 5.4% p.a upto Mid ‘07
2. Growth drops towards a “0% ” after Mid ‘07 towards mid ‘08

Related links

• Euro area - Production (IIP) grows in Feb’07
• Japan - Production growth rate drops in Mar’07
• USA - Production grows in Mar’07 at the slowest pace since Sept’05
• UK - Production - annual growth rate slips to a negative in Mar’07
• India - Production grows in Mar’07

• Europe - New Orders growth rate drops in Feb 2007
• USA - New Orders declines in Mar’07
• Japan - Dramatic fall in new orders in Mar’07 ( strongest fall since May ‘02 )

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Situation

• On a monthly basis prices rose by 0.79 % (0.30 % in Mar’07)
• On an annual basis prices rose by  2.20 % p.a ( 2.01% p.a in Mar’07)

Background

• The Bank of Japan (BOJ) raised the uncollateralized overnight call rate from 0.25% to 0.50% on Feb 21 2007 ( with a comment that future rate hikes would depend on growth and consumption)
• The BOJ left rates unchanged in their  meeting on May 17th
• Producer prices have been rising since Feb’07 ( 1.71% p.a) 

Conclusion ( click on image for a better visual)

Producer prices look like heading towards a 1.35% p.a

The possible impact of the recent Producer prices and Consumer Prices on the Monetary Policy of the Bank of Japanwill be taken up in a separate report, due shortly.

Related Links

• Japan - Producer prices ( PPI ) inches up in Mar’07
• USA - Producers prices remain high in Apr ‘07
• UK - PPI Producer prices drop in Apr’07
• Europe - Producer Prices : Prices in Mar’07 rise at the lowest pace since Jul’04

• USA - Inflation rate (CPI) drops marginally in Apr’07
• UK Inflation (CPI) drops in Apr’07
• Euro area - Inflation (CPI) flat in Mar’07
• Japan - Inflation indices ( CPI ) deflate in Mar’07 - Bank rates likely to remain unchanged
• India - marginal drop in inflation ( CPI )

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Situation

• On a monthly basis prices rose by 0.97 % (1.36 % in Mar’07)
• On an annual basis prices rose by  3.17 % p.a ( 3.21% p.a in Mar’07)

Core inflation stands at 1.51% p.a ( was 1.70% in Mar’07)

Background

The Fed under these circumstances may not consider a drop in interest rates for their rate meeting due on June 27th

Related Links

• USA - Fed meeting : No change in interest rate ( Fed remains open to hiking rates)

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