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Corporate Jun 1, 2012

18 June policy: RBI is caught between rock and hard place

By Sourav Majumdar

After the disastrous fourth quarter growth number of 5.3 percent in 2011-12, comes another number which will further compound the dilemma and make it tougher for the Reserve Bank of India (RBI) to take a call on further rate cuts. The HSBC Markit manufacturing Purchasing Managers' Index (PMI), an indicator of business expansion, came in at 54.8 in May, almost flat compared to the April number of 54.9. A number of over 50 indicates expansion.

But the number is even more significant for the following reason: "Strong demand for inputs, coupled with reports of limited supply, led to another rise in input costs during the month. The rate of inflation was little-changed from that seen in April. Indian manufacturers passed on higher input costs to their clients in May. Output prices rose for the 33rd month in a row, and at one of the fastest rates in the history of the series," a statement from HSBC announcing the latest number elaborated.

RBI may need to take a relook at the growth-inflation balance and examine whether it can consider putting growth ahead of inflation.

The signal, therefore, is that inflationary pressures are still very evident, making the central bank's task even tougher, after the nine-year-low fourth quarter 2011-12 (Q4FY12) growth figures showed growth was seriously affected now and something needed to be done. While most economists reckon there will once again be pressure on RBI to consider another round of rate cuts on 18 June - finance ministry mandarins have been talking of it often - RBI Governor Subbarao will now have to weigh the possibilities very carefully. In April, RBI already effected a deeper than expected cut in the key repo rate of 50 basis points against expectations of a token 25 bps cut.

The latest growth figures, of course, also mean RBI may need to take a relook at the growth-inflation balance and examine whether, given the gyrations of the rupee and its depreciation, it can consider putting growth ahead of inflation in its list of concerns. However, economists reckon it will be increasingly tough for the central bank, particularly with the latest PMI number.

Says Leif Eskesen, Chief Economist for India & Asean at HSBC: "Activity in the manufacturing sector kept up the pace in May with output, quantity of purchases and employment expanding at a faster pace. New orders decelerated slightly led by domestic orders and stock levels rose, suggesting a slight moderation in output growth going ahead."

"Input and output prices rose at a slower pace than in April, but inflation is still high by historical standards and capacity remains tight with backlogs of work rising and supplier delivery times lengthening. In light of these numbers, the RBI does not have a strong case for further rate cuts, which if implemented could add to lingering inflation risks," explained Eskesen.

However, Dipankar Mitra of Motilal Oswal does not seem to entirely agree on the rate action front. Says Mitra: "Nominal GDP is nearly certain to miss the FY13 date to reach the $2 trillion mark unless the INR (rupee) rebounds to 50.5/USD level. On the positive front, expect fiscal deficit and current account deficit (CAD/GDP) ratio to improve on falling oil and commodity prices. The order of the day is determined policy response, including monetary easing." Mitra said he expected a cut of at least 25 bps in RBI's 18 June policy.

A comment in The Wall Street Journal on Friday, titled "India's woes are of its own making", however, says a better approach than leaning on RBI would be for New Delhi to enact progressive policies to support investment. "Politics would make that difficult, though, and India's economic parameters could get worse," says the Journal. "New Delhi could find this difficult cycle is very hard to break."

Indranil Pan and Shubhra Mittal of Kotak Mahindra Bank feel RBI's call for a pause in rates is unlikely to change. "Talks have started doing the rounds that the RBI could cut policy rate in the 18 June meeting. However, we do not think this as a likely event," says Pan.

"With no hints of fiscal consolidation yet, the effect of monsoons yet to emerge and inflationary pressures from currency depreciation to probably sustain, the RBI should be on a wait-and-watch mode even now. We also do not anticipate any CRR (cash reserve ratio) cut in the next policy meet and the firepower of the CRR is likely to be maintained for distressed times," he explained.

A report from securities firm Anand Rathi also underscored the serious dilemma facing policymakers. "The GDP data once again reiterated that India is passing through a serious economic situation. Without decisive policy actions, the country is likely to plunge into an even more severe situation," the report warned.

But the Anand Rathi report has called for liquidity easing instead of rate action as a more effective tool. "Despite the marked across-the-board growth slowdown, stubborn inflation is unlikely to allow the RBI to undertake any meaningful policy rate cut. Rather than the policy rate, we expect the RBI to focus on liquidity easing. We feel that this would more effectively bring down market interest rates," the report says.

The only redeeming feature of the GDP data release was the slight traction in fixed investment, which, we feel, shows an uptake in the replacement capex. With positive policy actions, this could be a harbinger of a new capex cycle, which should boost India's GDP growth in FY13 and beyond, it adds.

by Sourav Majumdar

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