Posts Tagged ‘LAF’

Weekly Update 5th – 9th July 2010

The global markets fell in the week gone by as the manufacturing growth exhibited weakness from China to U.S. The investor’s across the globe became nervous with the fading signs of global recovery. G20 leaders said that the limited demand in advanced economies has left the world reliant on emerging markets, led by China, to drive a recovery is “uneven and fragile.”

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China’s manufacturing growth slowed more than expected in June adding to the concerns that the fastest- growing major economy is cooling. The government’s Purchasing Managers’ Index declined to 52.1 from 53.9 in May. In the U.S., manufacturing slowed in June with the cooling demand from rest of the world.

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The Institute for Supply Management’s gauge of manufacturing fell to 56.2 from 59.7 a month earlier.

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As anticipated in our last two editions, RBI raised the policy rates i.e. Repurchase and Reverse Repurchase rate by 25 bps taking it to 5.50 percent and 4 percent respectively as a part of the calibrated exit from the expansionary monetary policy. The strong growth shown by manufacturing sector especially capital goods sector, acceleration in credit growth and the widening current account deficit helped RBI to take such a step in order to anchor inflationary expectations going forward. In order to address the liquidity situation which is currently in deficit mode under LAF operations, RBI allowed banks to borrow to 0.5 per cent of their net demand and time liabilities (NDTL) even in case of a shortfall in maintenance of statutory liquidity ratio (SLR) till July 16, 2010.

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The expectation of hike in policy rates by RBI was very much priced in and will not have any bearing effect on the stock markets. However expecting good monsoon, the market was in the belief that inflation will come down in the months to come. But the recent numbers from IMD suggests a relook as so far the monsoon was 16 percent below normal in June 2010.

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Indian stock markets were holding on when all the world stock markets are falling but one should be very cautious when world markets are falling so much as Banking and IT sector are showing some weakness. Nifty has support between 5200-5100 levels and Sensex between 17300-17000 levels.

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Gone was wholly a brutal week for commodities. After the fourth quarter of 2008, first time commodities witnessed quarterly decline. Even the topmost hot favorite of investors gold and dollar index toppled down as money manager’s shifted their attentions towards euro, which saw a decent rise last week. Poor economic data’s in a row further pave the path for selling. At present one should wait for the clear trend. Base metals and energy have already seen a steep decline, may trade in a range for the time being. Similar story is of gold and silver.

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RBI hikes policy rates by 25 bps, surprises on timing

The Reserve Bank of India (RBI) in the post market hours on Friday evening hiked its benchmark policy rates repo and reverse repo by 25 basis points (bps) in order to check the surging pace of price hike and cushion inflationary expectations which have been threatening to move out of central bank’s control.

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The hike while was well anticipated, the timing of the announcement was an absolute surprise. Analysts have been anticipating a mid-cycle hike right from the release of central bank’s annual monetary policy statement in April. However, the euro zone sovereign debt crisis and the recent liquidity crunch have been weighing on the side of keeping status quo on policy stance.

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The expectations of a mid-cycle action increased after the inflation data released in middle of May showed wholesale prices index (WPI) reaching double digit levels. The RBI however remained silent. Again when the empowered group of ministers (EGoM) hiked fuel prices on June 25, analysts expected RBI to act immediately to counter the inflationary impact of partial deregulation of auto fuels and hike cocking fuels. No action however came at that time.

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Now that the scheduled review is just around four weeks away (July 27), most economists were expecting that the RBI will wait for the policy review. However, surprising the markets in a classical way, the central bank increased the rates when no one was anticipating.

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Notwithstanding the surprise though, the policy action is a welcome move as inflationary tendencies have been increasing sharply over last few months. The central bank, according to many observers, is already behind the curve, and may have to pick up the pace of policy tightening going forward if the pace of prices hike in the non-food manufacturing space continues.

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The timing and extent of hike also suggests that the central bank will further raise policy rates in the scheduled review. In fact, by hiking by 25 bps now, the RBI has given itself more flexibility for the forthcoming review where it can now choose among a number of permutations and combinations of policy and reserve rate mix. It may choose to hike everything (repo, reverse repo and CRR) by 25 bps or may leave CRR alone and hike policy rates by 50 bps. A few other combinations are also plausible.

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Justifying the initial delay in policy action and the actual timing of the move, the RBI stated, “This mid-cycle policy action has been warranted by the evolving macroeconomic situation. Even as data for real GDP growth and WPI inflation became available by mid-June 2010, it was considered inadvisable to raise the policy rates as the financial system was dealing with liquidity pressures…Through the month of June, liquidity under LAF operations remained in deficit mode. Consequently, the call rate moved up significantly, resulting in an effective tightening at the short end of the yield curve. The liquidity situation has since begun to ease”.

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Since the RBI expects that liquidity may continue to remain tight for some time, it has also extended the additional liquidity support to scheduled commercial banks under the LAF to the extent of up to 0.5% of their net demand and time liabilities (NDTL) up to July 16, 2010. The measure was first put in place on May 26 after liquidity scenario tightened following the advance tax outgo and huge payments for the 3G spectrum by telecom operators and was earlier set to expire on July 2, 2010.

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While the two moves may seem contradictory, the RBI didn’t leave the matter to be explained by analysts and added in its statement, “It should be noted in this context that the liquidity easing measures have become necessary to manage what is essentially a temporary and unanticipated development. In no way should they be viewed as inconsistent with the monetary policy stance of calibrated exit, which remains focused on containing inflation and anchoring inflationary expectations without hurting growth”.

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