RBI’s Measures- Too little too late


Dear Investor

RBI suddenly woke up last week from deep sleep and realised that something went wrong. Then in Hoch poach, decided that now, we should take control of the market and should stop Rupee’s further slide, as if they were comfortable till 60. In hurry, they announced measures to tighten the liquidity, also directed Banks to reduce exposure to currency futures and SEBI also took strict measures.

Indeed, it was futile effort. B’caz second day, RBI official conveyed that RBI will let market to determine Rupee value and they just want to curb volatility. You took steps first day and tried to reverse it second day with statement!!

I have been writing since end of 2010 that RBI is behind the curve and that is forcing RBI to take actions which are not in interest of the economy and nation. RBI was late in hiking of rates at first place and that compelled RBI to raise rates to the tune of 8.50% in 2012, while with real rise in economy in 2007, RBI could contain inflation with mere 7% interest rate(Repo). Does this not show the inefficiency of policy measures?

Let us come straight to the question – Will RBI raise rates from here or will slash?

Some data first. Because, Data will determine RBI’s further action.

WPI inflation is now at 4.86%, more than 50% down from above 10% in 2011-12.

GDP is at 4.8%( last quarter) lowest of the decade.

Current Account deficit stands at 4.8% of GDP. Highest of last 3-4 decades.

External Debt has risen 350% times since 2004, stands at $ 350bn.External Debt has more than doubled since 2008.

Industrial Production index oscillated between 5% to 10% between 1994-2010. But, between 2011-2013, it is fluctuating between -5% to +5%.

Business confidence index reading has mostly stayed above 60 since 2005. But, since last quarter of 2011, it has been in the range of 48-52. Below 50 indicates contraction and above 50 indicates expansion.

Personal Savings rate has dropped to 9.3% from high of 23.15% in 2010 and average of 16.5% between 2004 to 2010.

RBI’s own findings of Industrial Outlook Survey-2012-13

  • Demand conditions in the manufacturing sector weakened during 2012-13, as reflected in the drop in production, weak new orders growth, declining capacity utilisation and subdued exports and imports.
  • The optimism on financial condition also showed some moderation with overall financial condition moderating and availability of finance remaining stagnant. Cost of external finance is perceived to rise, though by a lower proportion of respondents as compared to a year ago.
  • Profit margin continued to remain negative during the year and dropped further during Q4: 2012-13.
  • Cost of raw material continued to rise whereas sentiments for rise in selling price declined indicating lack of pricing power.
  • Business Expectation Index (BEI) based on assessment moderated during the year and in Q2:2012-13 reached a level seen at the onset of financial crisis in Q3:2008-09. The BEI based on expectations has been declining since Q3:2010-11 and remained more or less flat during the year.

Above data doesn’t need elaboration. It paints very grim & gloomy picture. Economy is in deep trouble. Those companies having high debt burden(domestic or external) are facing severe problems.

At home, Interest rates are up hence deleveraging is not happening and those raised money from international market, are in bigger trouble. Those firms, borrowed in dollar when rupee was 50 or say 55 will have to shell out 20% and 10% more respectively just to make up rupee depreciation difference, apart from interest.

That could be one of the reason, companies are establishing subsidiary or launching new projects outside India(mostly in developed world). Because, interest rates are low in developed economies and it helps them to avoid currency volatility.

RBI acted on 16th July by hiking rates as if they were comfortable when Rupee breached 50 and further 55-57-58. Please excuse me but RBI Governor should have courage to take bold actions.

Hence, it is very clear RBI is in no position to increase rates even if it chooses not to slash.

Now, let us focus on how to come out of this recession….what measures can ensure us a growth back on table…

What is the way out?

One word answer is “Growth”. Solution of all problems lie in Growth. Some fear that it will give way to inflation to rise back to double digit zone. But, Inflation is just not because of demand, it is because of supply problems in most of the cases. Vodafone was charging Rs. 16/minute but when competition increased and more telecom companies were allowed, though inflation went up, though rupee depreciated but call rates have continued to fall. Wherever Govt has freed the sector, cost has come down, it has not generated inflation.

But, it took years for Govt to allot mining and oil exploration licences. Sunil Mittal, Posco have decided to withdraw. Farmers are paying very high prices for fertilizers because we had no or very limited capacity expansion in fertilizer industry in last 2 decades. Just to raise tax revenue of Rs. 18000 crore from one company(Vodafone), Govt brings in the rule with retrospective effect which in turn makes FII to withdraw and new entrants to delay investment decisions.

But, All know and are convinced that once India starts clocking around and above 7%, FII,FDI, Dollars will start salivating and flock back to India market. Who does not want pie of our market? We are one of the largest market of the world. Marc Faber is highly recommending India to his clients in Asian region.


How to bring back Growth?

Cut the interest rate. There are no free lunches in the world. For Economy to grow and to alleviate people from below poverty line, to increase supply of goods and services, to meet demand issues, to ease budget deficit and thus revenue deficit, to address current account deficit and last to save rupee, the only Solution is to cut interest rates sharply as soon as possible.

At the bottom of the crisis, US decided to cut rates sharply and to keep it there for extended period, that forced capital hiding in savings account, offshore, foreign investors, companies and investors to flock back to equity, commodity market. That increased fund flow, improved confidence of investor and consumer. Not only that, US could address current account deficit problem and could alleviate concerns of its ability to service external debt. We have similar problems. Yes, some may argue that Dhaval, US is developed and large economy while India is small economy. Middle of ocean, when cyclone hits, whether you have large ship or small boat, both should try to come out of cyclone. Was that right way or wrong discussed only if you are saved.

It is not less than cyclone when GDP is at decadal low, Industrial production, too, at decadal or two low, current account deficit at all time high and business confidence is at bottom.

Yes, there can be a argument that Dhaval, rate cuts will immediately drive Oil and Gold consumption to higher level and that will widen our trade deficit and that will put pressure on rupee !!

No, previous episodes do not suggest that. Even 2008 event does not support this argument. Even our own experience of last 1-1.5 years differs.

Say for Example – RBI cuts rate tomorrow by 1%. You will have immediately huge dollar inflow in both Equity and Debt market. Those funds, FIIs, and SWFs sitting on sidelines waiting for an opportunity, will rush to invest. We will have very good dollar flow to tackle our current account deficit and that will drive rupee up. Now, on other side, the fear is, would that not drive consumption up immediately? No, because, when RBI cut rates, Banks are not forced to pass it on imminently. Banks take 3-6 months and recently though RBI has cut the rates by 1.25%, Banks have passed on only 0.50% to consumers. Meaning, Banks will take time to start lending at lower rates. In between, you have 6 months to 1 year to align policies to stable the market and excesses.

US have eased its monetary policy to historical extend since 2008( since crisis hit)but if you look at US Dollar Index, it is still at the same level, where it was before crisis and before easing. In fact, it is up. Average of 2007-08 of Dollar Index comes around 77-76, when US was in middle of crisis and now it trades around 82.

Similarly, look at Euro, European crisis erupted in 2011-12. Average of 2010-11-12-13 comes at $ 1.35 and Euro trades at $ 1.32 right now. Meaning, European Central Bank has eased it monetary policy to historical extend but its effect on currency is almost negligible.

IN our own case, whenever RBI has eased, it has brought in foreign capital, it has driven rupee up.

Therefore, fear of currency depreciation on account of monetary easing is misplaced.

Technically, as I have written earlier, Rupee may trade between 58-62 for next 1-3 months and will form the top around this level. I do not see Rupee jumping to 65 and higher as talked by analyst at this point.

What are expectations?

I have no doubt in mind that there is only way to come out of this terrible period and that is rate cuts. Un till it is done, Economy will continue to languish at bottom, industries will remain in trouble and as data points suggest that consumption has started slowing, First time in decade, Car and 2 wheeler sales have come down, truck sales are down now for more than a year.

I do not expect Equity markets to scale newer highs and stay there unless rate cuts create favourable atmosphere. Results of Apr-Jun, 2013 quarter will sure reveal the pain in the economy.

In short, there is no better investment than Debt(Liquid, short term and Gsec), un till interest rates come down.

Therefore, stay invested in Gsecs and other debt –money market instruments with preparedness to bear short term pain.

Caution: If RBI delays the rate cuts and meanwhile Federal Reserve starts tightening aggressively, RBI will loose this easing opportunity and will have to raise rates to stop Global Capital flying out of domestic market, leaving our economy and market in shambles. Though Big investors, traders and insiders do not expect much tightening.

Hope: Coming September, Present RBI Governor retires and Govt is in no mood to extend his term. I hope, Govt will surely appoint someone whose thought process aligns with Govt and its agenda of 2014 election. To improve confidence level in the economy to face 2014 election, cost of money(interest rate) should be brought down. Hence, I am of firm belief, from September onwards RBI’s policy stance will favour Growth to inflation.



Dhaval Shah

Blog: https://investmentacademy.wordpress.com/ Cell: 98255 28815

Disclaimer: This is a free daily investment newsletter published by Investment Academy. This publication does not provide individual, customized investment or trading advice. All information is based upon data whose accuracy is deemed reliable, but not guaranteed. Performance returns cited are derived from our best estimates, but hypothetical as we do not track actual prices of customer purchases and sales. Author might have open positions in the stocks and Indices recommended above.


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