The FINANCIAL — Mumbai/Singapore-25 July 2011: Fitch Ratings says that it is closely monitoring the impact of the Reserve Bank of India's (RBI) anti-inflationary policies on the Indian economy.
While the RBI's tighter fiscal stance appears to be appropriate to contend with persistent inflationary pressures in the country, higher policy rates have begun to weigh on the economy particularly with respect to growth and liquidity.
Fitch has revised down its growth forecast for India's GDP to 7.7% in the financial year ending 31 March 2012 (FY12) from a previous projection of 8.3% (for more details, please refer to Fitch's full rating report: India, published on 24 June 2011). While restricting liquidity is an essential component of the monetary transmission of anti-inflationary policies, the agency is cautious on liquidity situation in the Indian monetary system.
As per Fitch's analysis of the liquidity condition, levels of various parameters used to measure liquidity are very comparable to the build-up phase of September 2008. The repo rate was increased from 7.75% to 9.00% during May-August 2008, while the current repo rate is 7.5%, up 250 bp, over March 2010 level. Expectantly, the overnight call money rates surged from 3.23% in March 2010 to 7.46% in June 2011 (May-August 2008: 5.9%-9.7%). Outstanding amount under the liquidity adjustment facility (LAF) recorded in June 2011 (INR1,020.9bn) was higher than the outstanding LAF observed in September 2008 (INR900.75bn). This provides reassurance to the RBI's willingness to supply liquidity. However, it testifes to the relatively higher current demand for liquidity in comparison to the period September-October 2008.
The stressful liquidity conditions peaked over September-October 2008 due to external credit crisis among other things. The RBI reacted by cutting interest rates aggressively and took other steps to ensure adequate liquidity in the financial sector. While these measures eased liquidity and revived growth, they induced inflationary pressures.
Currently on the domestic front, Fitch believes that the expected continuation of anti-inflationary policies, government borrowing and advanced tax payment in September 2011 are likely keep liquidity demand high in the near future. This period may coincide with external events with the potential to affect market sentiment adversely, resulting in further demands for liquidity. While the likelihood of such events is low, it may cause the RBI take actions similar to the ones taken after September 2008.
In this analysis, Fitch compares the relative liquidity conditions in the Indian money markets. For this purpose, the agency selected variables from money market, foreign exchange market and macroeconomic parameters. The relative liquidity conditions were assessed by aggregating the deviation measures of the individual variables from their long-term values.