RBI 50 bps hike – steep and late?

The sharp reaction by the market to RBI’s 50 basis points raise indicates that a majority of the market was caught unawares. After taking nine baby steps of 25 bps each since apr 2010, RBI suddenly decides to go ahead of the curve. RBI says that drivers for inflation now are different than they were in late last year. It was food inflation then, while it is high fuel prices and costly non-food manufacturing items now.

The argument seems odd given that crude had virtually took off with a 60 degree slope since oct last year. The commodities, which are a feeder into the manufacturing sector has long been on the boil. Since Apr 2010, Au 20%, Ag 100%, Cu 40% and Pd have risen 25%. RBI had at least three previous opportunities to rein in the headline inflation when they blamed sqaurely on supply side pressures. 

A good monsoon followed by a bumper crop output hasn’t cooled down inflation. Clearly, more than the supply chain losses, it’s the demographic pull which has not been matched by a corresponding supply infusion. This would need good CAPEX but the current RBI move will surely drive down investment even further.

The Governor further says that crude is likely to remain steep due to middle-east crisis and due to Japan situation where oil is being used as an alternative fuel owing to nuclear power shutdown.

The five regions of Japan hit by the quake contribute to about 8% of Japan’s GDP and expected to shave off at least 0.5% of GDP. So the overall slowness in economic demand should far neutralize the offtake of crude on account of power situation.

The cap on debt fund exposure is expected to release about 60,000cr of bank’s money held with the mutual funds. It will be some time before we can find out whether this money finds its way into advances to corporates OR banks use it for alternative purposes such as guarding against new NPAs arising out of higher interest regime etc. Introduction of Marginal Standing Facility (MSF) giving a corridor of 200bps [(repo + 100 bps)-reverse repo] for banks to play with, will help in easing out liquidity concerns in future.

A widening fiscal deficit should prompt the govt. to increase oil prices. A Rs 4 increase in petrol & diesel will likely push inflation up by another 0.5%. Further, IT Refunds of about Rs40,000 cr by may 2011 is analogous to an early wage hike. Govt. would have arguably benefitted by holding this fund for few more months.

US Fed’s bond buying spree is ending next month. Although Fed plans to keep reinvesting the securities, the shut down of printing machine should help in stronger dollar which usually leads to lower crude and lower commodities. The supply glut of steel, Cu, Zn in China and little monetary tightening there should further pull down the commodities given that China consumes 43% of world steel and 40% of world Cu. So from Q2 onwards, we should see some relief in prices of commodities and price of crude if North Africa situation doesn’t go beyond control.

The buzz in political circles is that Mayawati might go for an early election i.e. even before winter sets in north india. May be RBI has just done a favour to the Central Govt. with an aim to cool down prices in next 3-4 months even at the perils of growth.

The stock market will likely be now range-bound only in the short-term while the bulls enjoy their time in the shade.