The RBI has provided rates that banks used to give for one year deposits, all the way back to 1976. Here’s a plot of the “high” rates today (9.25 to 10%).
Much of the 90s was a 10 to 12% rate, and I remember that many bonds (IDBI etc.) offered 12%-14% to retail buyers. (We still own some 17 year bonds at 14% or so, which mature in 2016. )
RBI has raised interest rates by 0.25%, taking the repo rate to 8.5% and the reverse repo to 7.5%. The repo rate is what banks pay to borrow overnight from the RBI (against the collateral of government securities) and the reverse repo rate is what banks receive from the RBI for depositing money.
This is the 13th time rates have been raised since March 2010 (when it was at 4.75%).
The Cash Reserve Ratio, or CRR, which is the percentage of deposits banks need to keep as reserve with the RBI, stays at 6%.
RBI indicates that there may not be further hikes this year:
The projected inflation trajectory indicates that the inflation rate will begin falling in December 2011 (January 2012 release) and then continue down a steady path to 7 per cent by March 2012. It is expected to moderate further in the first half of 2012-13. This reflects a combination of commodity price movements and the cumulative impact of monetary tightening. Further, moderating inflation rates are likely to impact expectations favourably. These expected outcomes provide some room for monetary policy to address growth risks in the short run. With this in mind, notwithstanding current rates of inflation persisting till November (December release), the likelihood of a rate action in the December mid-quarter review is relatively low. Beyond that, if the inflation trajectory conforms to projections, further rate hikes may not be warranted. However, as always, actions will depend on evolving macroeconomic conditions.
They expect GDP growth to go down to 7.6% for 2011-12. This is a result of both monetary action and global developments.
In terms of money supply, they expect M3 to grow by 15.5% (it’s currently at 16.5%)
Savings Bank accounts have been giving a rate of 4% (recently upgraded from 3.5%). This was a fixed rate, and many banks used that low rate to good effect, offering customers substantial benefits if they kept money in an SB account.
Now, the RBI has changed this policy and allowed banks to set their own rates for SB accounts. With two restrictions:
a) All amounts below Rs. 1 lakh should get a uniform interest rate (per bank).
b) For above Rs. 1 lakh, banks can have a different interest rate based on amount, but banks can’t differentiated based on customer (like “premier” or “senior citizen” or whatever).
While this is prima-facie negative for banks, do not underestimate their ability to act like a cabal and collectively keep interest rates low. To avoid such a deal, I will note how banks change their SB rates and accordingly, move my transactional money to different accounts (currently HDFC bank).
The RBI statement is:
Customer service has always been on top of the Reserve Bank’s policy agenda. Recognising the need for revisiting the issues of customer service in banks, the Reserve Bank constituted the Damodaran Committee to make recommendations for improving customer service. The Committee has made several recommendations to improve customer service. We have decided to implement the recommendations of the Committee, on which a broad consensus has emerged, as also the action points which were identified by the Indian Banks’ Association (IBA) and Banking Codes and Standards Board of India (BCSBI) in the last Banking Ombudsmen conference.
That committee has recommended removal of pre-payment penalty for floating rate loans completely, and also for fixed rate loans where you don’t refinance the loan from another bank.
This is negative for banks. Great for everyone else, obviously.
Banks can also open branches without permission in Tier 2 areas (population from 50,000 to 1 lakh) – this was earlier limited to Tiers 3 to 6 only.
They will let Credit Default Swaps (single name corporates happen after end-November 2011. These should have started yesterday and were postponed.
RBI will also allow short selling of Govt securities with a clearer policy by end-December. Plus, market traded 2 and 5 year interest rate futures will be allowed, and they will look to expand liquidity in the G-Sec markets (please involve retail!).
Obviously banks are hurt, and the bank index is down 2.5%. HDFC Bank is down over 5.5%, while ICICI is only down 1%. Yes Bank, on the other hand, is up 3%.
Bond yields at the 10 year G-Sec were down to 8.68% from the 8.84% seen yesterday, perhaps more of a relief rally after the fear of a 50 bps hike.
Given that it is expiry day, and volumes recently have been low, and this is Diwali week involving holidays the next two days, I would not give too much importance to movements today. What is important now is to hear how banks change their lending and deposit rates, and to brace for the lower growth rate that RBI is talking about. I believe we will slow down substantially more by 2013, with inflation remaining high after March (when the base effect is gone).
The latest RBI macroeconomic survey (Oct 2011) precedes their announcement on monetary policy today. Key parts in their outlook:
Growth risks have increased on global headwinds, while inflation continues to be sticky adding to the complexity for monetary policy. Should global downturn accentuate, monetary
and fiscal policy space exists, though the current high inflation reduces the degrees of freedom somewhat.
The RBI has some pretty strong words – for a central bank – to describe the slowdown in growth. Few more nuggets on their outlook
The last line is informative:
So Deepak, What? I thought they will do 50 bps. Really. It seems crazy to have rates at 8.25% when we have inflation at 9.7%, and a 50 bps increase would be the correct measure.
But with so many statements saying growth is already moderating, there is the lag effect of past monetary actions, that they expect that their estimate of 7% by March 2012 is still valid, and so on it seems to me that they have slightly shifted their stance from primarily targeting inflation to moving towards growth.
Will they stop hikes? I doubt it, given the high headline number. But strange things have happened recently where every minister seems to have demanded that RBI stop hikes. Will they bow to political pressure? I hope not, but it could easily happen.
So yeah: I’m torn between 25bps and 50bps at this moment, with a very micro chance of no-hike.
Deepak Mohanty, ED at the RBI talks about inflation and its dynamics. I’d like to discuss part of that article, where he talks about the Inflation trajectory and how it will be determined – and make a case on timing. All emphasis is mine.
[Warning: LONG post]
Five factors will shape the inflation trajectory. The first is the trend in domestic food prices. Given the current stage of our economic development, the demand for food items, particularly animal protein, will increase with economic growth and a rise in income levels.
The demographic dividend, which has been contributing to our growth and productivity, has also raised consumption demand, particularly food.
As per a United Nations projection, a high consumption cohort in India’s total population will continue to dominate demand till 2040.
On the other hand, current per capita availability of cereals and pulses has been lower than that in the previous five decades. Oilseed production falls far short of demand.
Food prices in India are primarily determined by domestic demand and supply factors, and domestic price policy. With India’s domestic food prices being higher, import is not an option for reducing the prices. Hence, increasing agricultural productivity and expanding livestock production will be important for moderation of food inflation.
There are more issues with this.
1. We have a “minimum support price” for many agricultural items, and they have been given a 10% increase every year. This is the price the government pays for foodgrains, and you can expect that this is the lower limit for an annual increase in what comes to us.
2. Despite food rotting in its warehouses, the government wants to procure more food and hoard it in the name of a food security policy. Given that our productivity increases in agriculture aren’t that much in the first place, this idea itself will create supply shortages, which will drive up prices.
3. We disallow or discourage import of many foodgrains (or indeed, export of some). Free trade will help balance out prices in the longer term – however if other countries like the US heavily subsidize their farmers (more than us), high duties will be the only way to get a real counterbalance.
4. We don’t allow corporates or “non agriculturists” to become farmers. That takes away the much required capital that can really revolutionize farming.
Not only will this not get fixed in the near term – there is no political will, and farmers are a large vote bank – there is evidence we will go in the opposite direction.
Second, global commodity prices and, particularly, crude oil prices will have an impact on overall inflation. This requires policy initiatives towards energy conservation, efficiency in energy usage, recourse to alternative sources of energy, and step up in domestic exploration of oil and gas. For a fast growing economy such as ours, energy supplies will tend to lag demand.
It is, therefore, important to contain demand by letting the pricing mechanism play its allocative role. For this, it will be desirable to make further progress towards deregulation of petroleum prices, particularly diesel. This will not only allow the price signals to operate, but also balance the demand for petroleum products.
First, energy conservation is just not going to happen, or help. Asking people to switch off lights or geysers, or consume less, is horribly counterproductive – we have a country where too many people never even had electricity and they will slowly start getting connected to the grid. And with weather being extreme in most parts of the country, fans and A/Cs and heaters will be the norm – as they must be, because we have lost too many people to vagaries of weather. Net/net, the efforts to conserve power will be miniscule and led with silly tactics like switching off power for one hour (it won’t make a flying F of difference). The most efficient way, unfortunately, is load-shedding – and that, we’ll all agree, is retrograde.
Power is not stored – the minute it is produced, it has to be used. Much of it is lost along the way from the power plant to you. There is theft as well. There are ways to make this less inefficient but we haven’t invested in much. Even if we did, it would take years before we are able to; again, this is not a near term solution.
Alternative sources: only nuclear can provide the kind of power we need. Yet, we have all sorts of very intelligent people opposite really high quality nuclear power projects, even when we can get independent through thorium based reactors in the next two decades.
For cars, we have only crude oil based stuff – though it’s strange why we wouldn’t pursue a better CNG based solution (CNG has HUGE distribution issues). Even if CNG is a fossil fuel it seems there is more of it that we can harness, especially if we can get it from under shale rock.
Deregulation of diesel has to happen. But it won’t, as long as this government is in power because the folks out there are complete sissies. So, forget that bit.
Third, on the demand side, there is a need to shift aggregate demand away from consumption towards investment, to augment the potential output of the economy. The demographic dividend that we have in terms of addition of younger people to the labour force could be better harnessed when combined with increasing capital accumulation.
If the potential output does not expand, and the economy tends to grow faster than potential, it will result in overheating. The resultant inflationary pressures, by itself, will impact growth adversely. It is, therefore, important to enhance the potential output to dampen the inflationary impulses.
Essentially, he says that we must use our money productively – for example, instead of buying ipads, find a way of making ipads, so that ipads become cheaper. This will take tons of time, and the improvement in productivity can’t happen if you have rules stopping you. You need 7,000 permissions to start a business (I’m kidding, it’s only 6,500). You can’t fire people. You can’t become a better farmer because of lousy land laws and restrictions. You can’t get money from foreigners to invest into certain sectors. You can’t use biotech for better seeds, for the most part.
Look at the state of our colleges. We have IITs and NITs, but hardly any world class educational journals, campus research output or inventions coming from colleges. We don’t encourage our colleges to think about stuff that’s 10 years ahead – which, I hear, is the norm in the US. Education is primarily a business now, and the idea is to churn out well-mannered, job-wielding graduates. A whole generation of people has been lost to the IT coolie market whose idea of innovation is a web site that gives you discounted massages. This is skewed productivity. We need across-the-board innovation. Sure, some of it is happening, but our policies on education leave much to desire.
As an example, think of the number of innovations you have HEARD about in refrigeration, for India. Or in farming techniques or irrigation. Or water based transport. Reports have been very scarce lately.
Again, not only is this not possible to change in the short term, but there is no plan to change any of this at a policy level. A pockets of excellence we see is Gujarat – where there is fabulous governance.
Fourth, the level of the fiscal deficit and the quality of government expenditure have significant influence on inflation. Under normal circumstances, when private demand is buoyant, expansion in the fiscal deficit could be inflationary. Since private borrowing competes with government borrowing, it could exert upward pressure on interest rates. This could crowd out private investment, which would have an adverse impact on the overall economic growth.
Further, it also matters whether the government borrowing is for financing consumption or investment. The fiscal multiplier works better with investment, but a rise in government consumption expenditure could be potentially inflationary. There is, therefore, a need to move towards credible fiscal consolidation to contain demand-side pressures on inflation.
Oh this is fun. Without the 3G spectrum sale, or any serious disinvestment this year, the government’s accounts are in shambles. Watch the fiscal deficit till August:
We’re up 122,000 crores from last year, and the gap is likely to get wider. Not addressable in the short term and given our oil bill and two more elections next year and the government’s likelihood of giving sops to buy votes, this is not going to change in the short term.
Fifth, the stance of monetary policy and its ability to anchor inflationary expectations will affect how inflation evolves in future. The level of the policy interest rate should be such that it is neither too stimulative nor too tight.
This requires active liquidity management by RBI so that the systemic liquidity mostly remains in deficit in order to strengthen monetary transmission.
This is a key point. But with credit growth over 20% and money supply growing at 16-18%, we are focusing only on interest rates. Given our productivity challenges, we must keep money supply growth low – for which if reserve ratios need to be raised, some of our dollars need to be sold etc. (Read: Why only interest rates? and Stop Buying Dollars to Curb Money Supply)
Again, this is unlikely in the short term (though this policy can change fast) and also there is limited will for it within the RBI.
In all the cases above there is
a) no chance of a structural pause in inflation (other than some small spikes controlled)
b) little or no will to take strong measures to help.
If all the heavy lifting will have to be done by interest rates alone, we are likely to see double digit interest rates (10% to 12%) in the near future.
Reserve Money is the base money of our banking system, a level before the banks come in an multiply it with credit. It consists of the money RBI prints (“currency with the public”), the reserves banks keep with the RBI (which is a factor of how much they lend out) and some riff-raff. Typically, a growth in reserve money is useful because it helps keep prices stable as productivity increases in the system. But when you have serious inflation, the money growth needs to slow to control it.
Any slowing of the reserve money will appear in inflation and broader money supply (“M3”) only with a lag.
India’s grown money supply tremendously through 2007-08 and that continues to pose an issue today; with the brief dip in 08-09, when banks weren’t lending, the growth went back up to 20% and remains above 15% today.
In that context, though they’re not directly linked, this indicates why inflation is at 10% or more. When your base money grows 15%, and M3 (the “multiplied” money) grows 18-20%, you will need dramatic productivity benefits to match it.
An example: If Rs. 100 money supply would buy 10 mangoes at Rs. 10, and you scale the money supply to Rs. 120, then you need to somehow produce 12 mangoes – 20% more – for the price per mango to remain the same (Rs. 10). If you get productivity gains of only 10% – and are able to only produce 11 mangoes, then the per mango cost will go to nearly Rs. 11 (120 divided by 11 mangoes), an “inflation” of 10%. India’s productivity gains seem to be in the single digits – 6-8% – which means that money supply is growing much faster. It isn’t surprising then that we see inflation.
(I suggest that we sell our dollars and take the resulting rupees out of circulation – this will reduce money supply. It does cause liquidity issues, but it will address inflation better than interest rates IMHO)
Banks are supposed to keep a certain portion of their deposits aside in two compartmentalized areas: a Cash Reserve Ratio (CRR) where banks keep cash (not invested in anything) back with the RBI, and a Statutory Liquidity Ratio (SLR), in which banks are supposed to buy government securities, with a percentage of the money they have deposited. The two ratios reduce the amount of cash that banks can lend to other borrowers.
Today’s chart brings you these ratios since 1962.
The crisis years of 91-92 (when we were about to default) were the toughest – and banks needed to put more than 50% of deposits in G-Secs or with RBI as cash.
In 2008, there was a mini-peak with CRR reaching 9%. Total deposits – FDs+Savings+Current accounts – have been over 50,000 cr. for a while, so each percentage increase takes away more than 50K cr. from the lendable amount by banks.
This means that of the money you give a bank, 30% of it is allocated to lower cost lending (government borrows at around 8.5% nowadays, CRR gives no interest to the bank).
RBI moves rates up in it’s mid quarter review by 25 bps (0.25%) to 8.25%. This is a continuing anti-inflation stance that RBI has, which means raising rates until there are visible results on actual inflation.
A medium term look:
Inflation which is currently at 9.78% (See Article) is at the highest in a year. And worrisome is that inflation the biggest component, Manufactured Goods which is also the most persistent in that it is very difficult to reverse, is at a two year high (highest since October 2008).
The RBI Monetary review admits:
Read the rest of this entry »On Friday, the Reserve Bank of India will release the mid-quarter review of Monetary Policy (12 noon). Will it raise rates again, after 11 consecutive rate raises? We have seen rates rise from the 4.75% lows to 8% on July 26. In the mid quarter review, large policy decisions are not something we should see; it’s supposed to be just a review.
So no, just because it’s a review doesn’t mean big things can’t happen. And yes, it’s a good thing, because three months is too long to wait in the fast information age.
January started at 6.25% but the Jan meet saw RBI taking that up to 6.5%. March saw a 25 bps hike to 6.75%. In May we saw a hike of 0.50% in Repo along with a slew of policy changes, such as introduction of a penalty-rate Marginal Standing Facility, higher provisioning requirements, increased Savings Bank Account rates and so on. In June (I was on holiday, so no post), the repo rate was hiked another 0.25%. July saw a hike of 0.50%
A longer history:
(Do you like the charts at capitalmind.in? How can we improve? Please comment)
Raising rates was always meant to control inflation, which doesn’t look like it’s really getting controlled.
The chart of inflation at the primary and fuel level:
Inflation at the basic level doesn’t look like it’s ebbing. Plus, each new data release has revised past data significantly upwards, so there is some consternation that the recent numbers are even higher in reality.
There are multiple reasons that another hike is not necessary:
I think we get at least 25 bps. The RBI’s recent statements don’t seem very suggestive of a pause, and they really do a lot of gestures and postures before changing course. However, it’s important to keep questioning a theory; what do you think?
Copyright (C) Deepak Shenoy 2005-2012
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