A policy tailored to specific challenges

Posted on April 23, 2010 | Author: Pramit Jhaveri | View 683

The road ahead is fraught with some uncertainty, economies will continue to recover at differential rates and global markets will continue to be volatile.It is worth noting the emphasis that the governor has accorded to financing of the infrastructure sector.The governor has also rightly drawn renewed attention to inclusive growth.

artical Picture The RBI governor delivered a finely balanced and forward-looking monetary policy tailored to the specific challenges that the Indian economy is facing in the backdrop of a continued uncertain global environment and a domestic inflation-growth conundrum.

The change in policy rates was in line with market expectations and we believe that these will not impact growth. The monetary policy changes are in continuation of the path of gradual withdrawal from a purely expansionist policy necessitated by the global financial crisis.

The global financial markets have stabilised significantly since then and the IMF's estimates suggest that the world economy will start growing again in 2010.

However, we believe that the road ahead is still fraught with some uncertainty, economies will continue to recover at differential rates and global markets will continue to be volatile. This probably is the 'new normal' that the world will have to learn to live and cope with.
The RBI and the markets alike continue to be concerned about inflation as the key risk to India's growth agenda. Supply-side constraints and high food-based inflation are now slowly giving way to broader nonfood inflation driven by rising oil and commodity prices, benign global liquidity conditions and demand-side pressures.

Given this, the RBI's monetary policy objectives appear quite clearly to be to contain inflation and inflation expectations, to sustain and improve existing growth rates and to facilitate the government and private sector borrowings plans for 2010-11.
Market participants should be pleased to hear the RBI laying out the roadmap for the launch of several new financial market instruments. A vibrant Interest Rate Futures market, Exchange Traded Currency Options, Credit Default Swaps, STRIPS and Priority Sector Lending Certificates seem a distinct possibility now.

After a tentative start, Interest Rate Futures should finally start seeing activity once market players see relative value plays between the various tenor points on the yield curve.

The RBI has also initiated a number of essential moves on the improvement of financial markets infrastructure in this policy. We believe that the final goal will be to migrate to a Central Clearing Counterparty mechanism. This would achieve the dual purposes of transparency in trading and better control on systemic risk.
In addition, to the regulatory policy announcements that the governor has made related to the corporate debt and foreign exchange markets, it is worth noting the emphasis that he has accorded to financing of the infrastructure sector and the measures to facilitate this.

In addition, the governor has drawn renewed attention to inclusive growth via the expansion of the business correspondent universe and potentially via mobile telephony where penetration rates significantly exceed that of the current banking system.

Whilst we welcome the focus and regulatory changes related to infrastructure financing, we continue to believe that financing of this sector continues to be far too banking sector dependent.

In addition to the obvious 'assetliability mismatch' that financing of longterm projects creates in banks' balance sheets, further development of the corporate bond markets and channelisation of long-term savings to finance infrastructure projects continue to be the need of the day.
While commenting on supervisory measures for the banking system, the RBI governor has touched upon an important structural issue related to the presence of foreign banks in India. Quite clearly, the RBI's thinking in this regard is being influenced by learnings from the global financial crisis and with a view to provide greater regulatory control and comfort.

Citi operates as a wholly-owned banking subsidiary in certain emerging markets and we welcome the RBI's pronouncements on this subject and look forward to the presentation of a discussion paper over the next few months.
Several constraints exist currently which have precluded any foreign bank from making the transition from that of a branch to that of a wholly-owned subsidiary.

We look forward to a new roadmap and policy framework that would address the existing open issues and constraints. The issues to be addressed can be broadly categorised but not limited to issues of governance, ownership, branch licensing, access to local capital, stamp duty and taxation.
In summary, like domestic markets, we are heartened by the monetary and regulatory policy announcements made by the RBI.

As always some amount of uncertainty prevails going forward related to the monsoons, oil prices, capital flows, government divestment and other macro factors. The markets should be reassured that the RBI has plenty of policy and liquidity measures at its disposal and it has also exhibited a willingness to use them decisively in the past.

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