Mid-Quarter Monetary Policy Review: September 2011

Monetary Measures

On the basis of the current macroeconomic assessment, it has been decided to:

• increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from
  8.0per cent to 8.25 per cent with immediate effect.

  Consequent to the above increase in the repo rate, the reverse repo rate under the LAF will
  stand automatically adjusted to 7.25 per cent and the marginal standing facility (MSF) rate to 9.25
  per cent with immediate effect.

Introduction

Since the Reserve Bank’s First Quarter Review of July 26, the global macroeconomic outlook has worsened. There is growing consensus that sluggishness will persist longer than earlier expected. Concerns over the sovereign debt problem in the euro area have added further uncertainty to the prospects of recovery.

Domestically, even as many indicators point to moderating growth, both headline and non-food manufactured products inflation are at uncomfortably high levels. Crude oil prices remain high. Food price inflation persists notwithstanding a normal monsoon.

Inflationary pressures are expected to ease towards the later part of 2011-12. Stabilisation of energy prices and moderating domestic demand should facilitate this process. However, in the current scenario, with the likelihood of inflation remaining high for the next few months, rising inflationary expectations remain a key risk. This makes it imperative to persevere with the current anti-inflationary stance.

Global Economy

The global economy slowed in Q2 (April-June) of 2011. Lead indicators such as purchasing managers’ indices (PMIs) suggest a further moderation in economic activity in Q3, with the global manufacturing PMI approaching the neutral level of 50. In recent weeks, global financial markets have been rattled by perceptions of inadequate solutions to the euro area sovereign debt problem, exposure of banks to euro area sovereign debt and renewed fears of recession. Global recovery will also be affected by fiscal consolidation measures in some of the advanced economies.

In the US, apart from fiscal concerns, stubbornly high unemployment and weak housing markets continued to weigh on consumer confidence and private consumption. In response to the weakening of economic activity, the US Federal Open Market Committee, in its 9^th August meeting, indicated that it would keep the federal funds rate near zero at least through mid-2013.

Economic activity in the euro area decelerated significantly during Q2 of 2011 reflecting decline in both private and government consumption expenditures as well as deceleration in capital formation. Economic activity contracted in Japan reflecting the impact of the earthquake/tsunami. In contrast to advanced economies, growth remained relatively resilient in emerging and developing economies, notwithstanding some moderation in response to monetary tightening to contain inflation.

Domestic Economy

Growth

GDP growth decelerated to 7.7 per cent in Q1 of 2011-12 from 7.8 per cent in the previous quarter and 8.8 per cent in the corresponding quarter a year ago. Agricultural growth has accelerated, but industry and services have decelerated. The index of industrial production (IIP) slowed from 8.8 per cent year-on-year in June to 3.3 per cent in July. However, excluding capital goods, the growth of IIP was higher at 6.7 per cent in July as compared with 4.4 per cent in June. Cumulatively, the IIP increased by 5.8 per cent during April-July 2011, compared with an increase of 9.7 per cent in the corresponding period of the previous year.

The HSBC Purchasing Managers' Index for the manufacturing sector also suggested moderation. Corporate margins in Q1 of 2011-12 moderated across several sectors compared to their levels in Q4 of 2010-11. However, barring a few sectors, significant pass-through of rising input costs is still visible.

Monsoon rains so far have been normal. The first advance estimates for the 2011-12 kharif season point to a record production of rice, oilseeds and cotton, while the output of pulses may decline.

Inflation

Headline year-on-year wholesale price index (WPI) inflation rose from 9.2 per cent in July to 9.8 per cent in August 2011. Inflation in respect of primary articles and fuel groups edged up in August. Year-on-year non-food manufactured products inflation rose from 7.5 per cent in July to 7.7 per cent in August 2011 suggesting as yet persistent demand pressures. The oil marketing companies raised the price of petrol by ` 3.14 per litre with effect from September 16, 2011. This will have a direct impact of 7 basis points to WPI inflation, in addition to indirect impact with a lag. The new combined (rural and urban) consumer price index (base: 2010=100) rose to 110.4 in July from 108.8 in June. Other consumer price indices registered inflation rates in the range of 8.4 to 9.0 per cent in July.

Monetary, Credit and Liquidity Conditions

Year-on-year money supply (M₃) growth at 16.7 per cent in August was higher than the projection of 15.5 per cent for the year reflecting higher growth in term deposits and moderation in currency growth. Similarly, year-on-year non-food credit growth at 20.1 per cent in August 2011 was above the indicative projection of 18 per cent set out in the July Review.

Liquidity has remained in deficit, consistent with the stance of monetary policy. The daily average borrowings under the liquidity adjustment facility (LAF) were around ` 40,000 crore in September (up to September 15, 2011). Money and the government securities markets have remained orderly. In recent weeks, as a result of global risk aversion, the rupee has depreciated, which may have adverse implications for inflation.

Monetary transmission strengthened further with 45 scheduled commercial banks raising their Base Rates by 25-100 basis points after the July Review. Consequently, the modal base rate of banks rose to 10.75 per cent in August from 10.25 per cent in July.

Fiscal Conditions

The central government’s fiscal imbalances widened during April-July of 2011 reflecting, primarily, the impact of decline in revenue receipts coupled with pressures from non-plan revenue expenditures on account of higher petroleum and fertiliser subsidies. Fiscal deficit at 55.4 per cent of the budget estimates in the first four months of the current fiscal was significantly higher than that of 42.5 per cent during the corresponding period last year (when adjusted for the more than budgeted spectrum proceeds).

Summing Up

To sum up, developments in the global economy over the past few weeks are a matter of serious concern. Growth momentum is weakening in the advanced economies amidst heightened concerns that recovery may take longer than expected earlier. Although India's exports have performed extremely well in the recent period, this trend is unlikely to be sustained in the face of weakening global demand. This, combined with the slowing down of domestic demand, to which the monetary policy stance is also contributing, suggests that risks to the growth projection for 2011-12 made in the July Review are on the downside.

Meanwhile, inflation remains high, generalised and much above the comfort zone of the Reserve Bank. After slight moderation in July, non-food manufactured products inflation rose again in August, suggesting continuing demand pressures. Global crude oil prices have remained elevated despite weakening of global recovery. Moreover, there is still an element of suppressed inflation. Though global oil prices have moderated, the pass-through to domestic prices remains incomplete. Also, current administered electricity prices are yet to reflect increase in input prices, even as many states have initiated increases. Food inflation is at near-double digit levels, despite normal monsoons, underlining the fact that it is being driven by structural demand-supply imbalances and cannot be dismissed as a temporary phenomenon. The inflation momentum, reflected in the de-seasonalised sequential monthly data, persists.

Expected Outcome

The policy action in this Review is expected to:

• reinforce the impact of past policy actions to contain inflation and anchor inflationary expectations.

Guidance

The monetary tightening effected so far by the Reserve Bank has helped in containing inflation and anchoring inflationary expectations, though both remain at levels beyond the Reserve Bank’s comfort zone. As monetary policy operates with a lag, the cumulative impact of policy actions should now be increasingly felt in further

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moderation in demand and reversal of the inflation trajectory towards the later part of 2011-12. As such, a premature change in the policy stance could harden inflationary expectations, thereby diluting the impact of past policy actions. It is, therefore, imperative to persist with the current anti-inflationary stance. Going forward, the stance will be influenced by signs of downward movement in the inflation trajectory, to which the moderation in demand is expected to contribute, and the implications of global developments.

MArket Overview as of 13Sep....

GLOBAL INDICES

• Dow Jones ended moderately higher on Tuesday, supported by gains in stocks of GE and other industrial companies. 

• At 9.00 am in the morning, Asian markets were trading lower, with Nikkei trading 0.20% down and Hang Seng trading around 0.16% lower.

• Nikkei ended higher on Tuesday, supported by bargain hunting and as euro's fall against the yen halted. 

• FTSE index ended higher on Tuesday amid high volatility, led by banks which bounced back after recent falls, although investors’ sentiments were cautious

due to persistent fears of a Greek debt default and a sharp rise in Italy's borrowing costs.

   INDIAN EQUITY MARKET

• At 9.00 am in the morning, the SGX Nifty was trading 0.16% higher.

• Indian stock indices ended down on Tuesday after a volatile session on fears of potential Greek default and downgrade of French banks. 

• IT, oil and gas, and metal stocks surged with TCS, Infosys, and Wipro, ending up 0.8-1.2% as the rupee weakened to its lowest level in more than 15 months, raising the prospect of higher forex earnings. 

• Cairn India rose 5.6% as crude oil prices recouped.  

• Shares of Ambuja Cements, UltraTech Cement and ACC ended up 0.6-2.3% after Corporate Affairs Minister said that a preliminary probe by the Ministry had found no cartelisation by cement companies in India. 

• Banking and auto shares declined with ICICI Bank, SBI, and Tata Motors on fears that RBI may raise rates further. 

• L&T, HDFC, HUL and SAIL were among under performers, ending down 0.6-1.3%. 

DOMESTIC NEWS

• Asian Development Bank expects India to grow 7.9% in 2011 and 8.3% in 2012, lower than forecasts made in April of 8.2% for this year and 8.8% for 2012.

• Finance Ministry says that the government will be able to raise Rs 40,000 cr from sale of equity in state-owned companies this fiscal.

• RBI Deputy Governor says that the central bank will not intervene in forex market unless the situation is grave.

• Data from SEBI shows that significant outflows from equity exchange traded funds dragged down the net assets under management of the MF industry in August by 4.3% or Rs.31449cr to Rs.6.97 lakh cr.

• IRDA says individual members, including family members covered under any group health insurance policy of any non-life insurer, will have the right to migrate from such a group policy to an individual health policy or a family floater policy with the same insurer.

• Indian companies' capital expenditure in 2011-12 (Apr-Mar) is likely to be lower than in the previous year according to the RBI’s September bulletin.

• Oman Oil offers SAIL a joint venture partnership to set up a steel plant in the Middle Eastern country.

• Suzuki Motor decides to locate a planned new car factory in Gujarat for an investment of about $1.3bn.

• TCS partners with Felda Prodata Systems for joint development and delivery of IT services and solutions in the Malaysian market.

• Infosys Ltd partners with Singapore Management University to develop training programme content for Infosys employees.

• Bharti Airtel and Idea Cellular start issuing demand notices to mobile phone companies, their competitors, seeking an SMS termination fee of 10 paise for every text message.

• NSE is likely to launch a share trading platform dedicated to small and medium enterprises in the next two to three weeks.

• National Housing Bank raises the provisioning requirement for doubtful assets up to 100% and directs housing finance companies to set aside 0.4% of the total outstanding standard loans as a buffer.

• SBI, the Income Tax department, SBI Caps and Standard Chartered to get Rs.650cr from the liquidated assets of Harshad Mehta entities.

The emerging Economy

I

Indian Economy Next Quarter    India: Kal, aaj aur kal Growth forecasts continue to be revised downwards as the first quarter estimates showed significant moderation from before. Yet, the picture for the year is really not as gloomy as it is being made out to be. Not just us, there are some others who also forecast an up trend towards the fourth quarter, the question is by how much. At the current pace, our estimates still continue to be 8.3-8.5%. The reasons for our optimism are many. For one, the services sector has not been caught in a tail spin and has the strength to provide significant support – e.g. India just registered the highest growth globally in domestic air passenger traffic in July at over 20%, and tourist arrivals have seen higher growth in July, compared to last year. Strong movement in truck rentals and sales, reported by the IFTRT for August, shows that cargo movement has steady demand. Also, agriculture is set to do another good year, though some crops like pulses will still see setbacks. The problems lie essentially with manufacturing and construction – both these sectors however have volatile data. Cement production that registered 0.88% growth in Q1, according to provisional Ministry estimates, grew at 10.56% in July; the issues with IIP estimates are well known. So while it is clear that these two sectors are going through a downturn, there is still insufficient information about the extent of the downturn. Though the HSBC Markit PMI has shown four months of steady decline in the manufacturing activity index since April- here again, the index points essentially to a moderate slowdown with no signs of contraction in India, as opposed to other countries, pointing again to the strength of domestic demand. This strength is substantiated by credit growth, that is moderately lower for industry in July compared to last year (21.2% vs. 27.7%) and significantly higher for the services sector, commercial real estate, NBFCs and personal loans. Direct tax collections have also shown robust growth. The latest small business SME survey conducted by Indicus Analytics shows business confidence and prospects higher for Q2 compared to Q1. Though the index is still much lower than last year, the mood is upbeat across all regions for almost all industrial sectors. Interestingly investment expansion plans are significantly higher for chemicals and general purpose machinery. This is largely because past warnings of impending volatility have not fructified and export orders for the non-garments SME sector are showing no signs of slowing down. ACMA also reports that investment plans are very much on track this year, higher than last year. In effect, while growth this year will be nowhere close to the 9% that the economy could have turned out, the lows of 7% also are highly unlikely. Time and again, we find that the presence of strong demand being under-emphasised. This means that the resultant impact on growth is overlooked and the implication on the pressures on inflation are also not stressed enough. A related problem for the long term is, can a demand surge continue without significant surge in investment? For a few quarters, but beyond that demand cannot be sustained and neither can growth. So we do have this curious situation where internationally we could see a moderation in primary prices – the Reuters/Jefferies CRB Commodity Index that peaked in April has been quite flat over the past two months, crude has softened too – while domestically we would continue to bear the brunt of price rises. The continuous rise over the past two months in weekly primary article inflation shows the persistence, while our SME survey also shows higher pressures from input costs. With little being done to address supply side constraints, price rises are inevitable. The impact of the softening of international prices could come through, though for crude the fat subsidy bill shows no signs of lessening. For the WPI, therefore, the path seems set to stay high through the next quarter, with inflation moving below 7% by January. The question remains, where are we heading? The Planning Commission has lowered the 12th Plan growth target from 9.5% to 9%, the government looks happy to settle for 8.5%, which leaves us around where we are now. A small positive sign does appear on the horizon though - a new manufacturing policy is to be out soon, it remains to be seen whether this will change around long term growth prospects.

TERM INSURANCE

Term Insurance is one of the most misunderstood products in India (Of
course that is applicable to the concept of “Insurance” in India.) Unless
there is a legal compulsion, the penetration for Insurance product is
negligible
Few Interesting points about the Term Insurance are:
 Main reason for saying “No to Term Insurance” lies in the response of a common person “Why
should I pay annually for a product if I cannot get back anything in return?”
 Very few people (or to that extent Financial Advisors) understand that it is the  cheapest and
simplest form of Insurance. Here, you are paying a pre-decided premium and in return your
family gets a pre-decided amount in case of your death.
 Main reason for low cost of Term Insurance is that there is  no savings element involved here.
Only Mortality Cost is involved in the premium. Hence Term Insurance gives Value for Money.
 There is no maturity benefit for Pure Term Plans. So the most common question is “Why should I take
this Plan”?- Because it provides a  safety net for entire family. It ensures that the family is not
burdened for  future  liabilities like livelihood of surviving  spouse, child education and marriage,
outstanding loans etc. When a breadwinner dies, one cannot replace the human being. But we can
surely reduce the financial difficulties arising due to such demise.
 The amount of Insurance cover and the term of Insurance policy  depend on person to person. But
ideally, the term of insurance cover should be in line with  the  retirement age. In Indian scenario,
10-15 times of annual income of a person is  considered to be an ideal life insurance cover.
However, factors like inflation, earning potential and future  liabilities also need to be considered
before deciding the life insurance cover.
 One should  review the  Life Insurance Cover every 5 years in line with increase in his earning
capacity, increase in future liability, changes in mortality rates.
 With increasing life expectancy in India, the premium rates for Term Plans are decreasing gradually. So
one needs to evaluate the Term Insurance Policy and look  for a  competitive premium. For
example, if a person of age has taken a Term Insurance 3 years back, he can get a Term Insurance at
better premium with Kotak Preferred Term Plan (even after considering the increase in age of 3 years).
 First Question a Financial Advisor needs to ask his client is “How much is your LIFE COVER”. Second
Question  “How much is your  FAMILY  HEALTH INSURANCE COVER” and then the savings and
Investments part comes into picture.