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RBI's Monetary Policy is Crucial

Nandkumar Surti, CIO, J.P. Morgan Asset Management says liquidity will ease and the commodity prices will be the key to watch

In the second part of this three part interview; Nandkumar Surti, CIO, J.P. Morgan Asset Management shares his views on liquidity, gold and deposit rates

The RBI has a balancing act between inflation and growth. Even if rates rise, you don’t see GDP growth being hit?
I agree on the fact that the RBI’s monetary policy will continue to play a very crucial role. But you must distinguish between interest rates rising and RBI rates rising. Lending rates will not rise in the same manner as RBI rates going up. On the back of the liquidity tightness, lending rates have already seen a reasonable hike. So I do not think there will be a 1:1 co-relation between RBI rates and lending rates. If RBI increases its rates by 75-100 bps, lending rates will probably go up by 25-50 bps from the current level. Market rates have already tightened substantially in the past four months. It’s only in the past few days (as in the first week of January) that the market is now seeing some positive signs of liquidity. This is because the RBI is buying back government bonds. And there is also some amount of government spending.

So even if the liquidity situation eases, the RBI will still come out with a rate hike end January.
Yes, because of inflationary issues which we discussed earlier. Let’s look at one question: Is the RBI’s move to increase rates affecting consumption in any way? I don’t think so. Take a look at the trends in discretionary spending. Look at the sales of 2-wheelers and 4-wheelers, both of which require financing. Look at the sales of consumer durables. Consumption in all these sectors is going strong. Tightening monetary policy is not adversely affecting consumption.
Of course, if the RBI wants to give a jolt to the market, it may do a bigger rate hike or may seek some dramatic action like letting liquidity tightness continue for an extended period of time.

You talk of strong consumption trends. Is not a lot of it coming from rural India?
The wealth effect has been fantastic. And a contributor to this has been real estate. Land prices in rural India have gone up between 30 and 70 per cent over the past year. This is creating a tremendous wealth effect and the discretionary spend is rising.
At the margin development is taking place. Construction activities have increased. Highways are being built. So a piece of land close to a proposed highway would have had no value earlier. But now it definitely will.

According to the World Gold Council, demand for gold in India rose to 650.4 tonnes during January-September 2010 as compared to 363 tonnes in the corresponding period in 2009. Is this robust demand due to more money in the hands of rural India?
I think gold is held more in connection with the view on the US dollar as well as the European economy. However, it is obvious that Indians have a natural affinity towards gold. To add to it is the hype that gold prices are increasing. This means that if there is an impending event, like a marriage planned a year down the road; individuals will look to buy more gold now due to inflationary expectations as far as the yellow metal is concerned. All these factors play a role in generating demand for this asset class.

What was the cause of the liquidity tightness?
There were multiple reasons. It all began with the 3G and broadband auction which brought in more than Rs 1 lakh crore. So inflows were huge but expenditure did not materialise. Then there were blockbuster IPOs, in the form of Coal India Ltd, Power Grid Corporation of India and Manganese Ore. The amount of demand that these disinvestments attracted was huge and large amount of money were pulled out from circulation during these public issues. All these three IPOs collectively attracted more than Rs 3.80 lakh crore from the domestic investor, so you can imagine the liquidity strain it would have caused during that period when the IPOs came out back-to-back.
Corporate investors got into the financing of IPOs. They also invested in the IPOs because they saw a huge discount that they were being offered at. Money market mutual funds began to face huge redemption pressures. Banks were anyway gasping for liquidity. As a result bank deposit rates started moving upwards. In the past one month (till early January 2011), deposit rates shot up by 100 bps. Then there was the December quarter advance tax and the December quarter ending.
Despite a high current account deficit, the FII flows were strong so the problem was not compounded, or else the liquidity problem would have been very serious. So as you can see, it was a combination of various factors that culminated into the liquidity tightness.

Do you see the liquidity tightness easing?
Yes, liquidity has eased off on the back of government spending, but I would not be surprised to see the 6-month to 1-year rates would go back to 9.50-10 per cent levels. March maturity instruments which were trading in December 2009 at 9 per cent levels are today trading at 7.5 per cent levels — a drop of 150 bps. But if you look at April 2010 maturity instruments, the rates have dropped by hardly 30-40 bps. I think these rates will start rising. The average deposit growth has only been 14.7 per cent. But the larger issue is that if you look from March 31, 2010 till December end the growth in deposit has been around Rs 3.06 lakh crore. So even if we assume a 15 per cent growth in deposits for the current fiscal year, it translates to Rs 6.70 lakh crore, which means a huge gap to be covered in just three months. And I am not even taking the RBI target of 18 per cent.

Bank deposit rates have not kept pace with inflation. And when you take the tax impact into account, the real returns are negative. Is that why amount of currency with the public has risen?
Currency with the public has risen. In view of inflationary expectations and anticipated expenditure, the public will hold more cash in hand. Look at a normal household budget, their monthly expenses have shot up. To add to it, we have just come out of the festival season where expenses are anyway on the higher side.
However, to add your statement on real returns being negative, interest rates on one year bank deposits have moved from being 6 per cent at the start of the year to around 9.5 per cent levels now. So it shows that banks do need the money. And right now credit growth is at 23.7 per cent. If that starts galloping, then the demand for deposits will rise further. Nobody in the finance business wants to lend and then borrow. They want to first sit on cash and then take on lending activities. So banks will be in an aggressive mode going forward. And systemic liquidity will continue to be negative as long as high inflation and inflationary expectation remain. The RBI target on systemic liquidity is (+/-) 1 per cent of NDTL. And I think it is going to tilt more towards -1 per cent of NDTL.

Read the last part of this interview on February 25, 2011

To read the first part click here