RBI vs. Spiralling inflation   Jul 09, 2010

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FD Rates (1-Yr)	5.00%-6.50%

Impact

The Reserve Bank of India (RBI) increased its key short-term lending and borrowing rates by 25 basis points each with immediate effect on July 2, 2010, in order to combat spiralling double digit inflation.

The repo rate has been increased from 5.25% to 5.50% and Simultaneously, the reverse repo rate has also been increased from 3.75% to 4.00%

The Wholesale Price Index (WPI) inflation for the month of May 2010 (released in June 2010) inched-up in doubled digits at 10.16%, after showing signs of cooling-off in the previous month (9.59% for April 2010). Moreover, WPI inflation numbers for February and March 2010 were also revised upwards to 10.06% and 11.04% respectively.

The fact that non-food inflation and fuel price inflation are accelerating, also called for this intermediate rate hike.

RBI’s Deputy Governor, Dr. K.C. Chakrabarty justified this intermediate rate hike by saying, "We had to control credit demand, especially unproductive demand has to be curtailed". Additionally, he said, "If inflation rises further, there will be more rate hikes".

Finance Minister, Mr. Pranab Mukherjee also reacted to the policy rate hike by saying, "These measures are desirable given that core inflation has risen and credit situation is tight".

We believe that RBI will certainly continue adopting the calibrated exit path by raising policy rates by 25 basis points at each step to normalise policy rates and make them more relevant to the current high economic growth and spiralling inflation. Hence, RBI in its next policy review meeting (scheduled for July 27, 2010) may increase the policy rates again by another 25 basis points.

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Impact

Investors’ in the current fiscal year may find Initial Public Offerings (IPOs) from leading private life insurance companies such as SBI Life Insurance, HDFC Standard Life, Reliance Life Insurance and ICICI Prudential Life Insurance. The insurance regulator - IRDA (Insurance Regulatory and Development Authority), and the capital market regulator "SEBI (Securities and Exchange Board of India) have resumed the process of listing insurance companies and necessary guidelines are under preparation.

In order to prepare the final draft on the valuation method to be adopted, the insurance regulator has already restarted consultations with SEBI. Moreover, to provide transparency to investors’, disclosure norms for life insurance companies intending to list, are also in the final stage of finalisation and are likely to be released by the end of July 2010.

As per the existing guidelines, for an insurance company to list on the stock exchange, it is required to be operational for at least 10 years before listing. It was only last year that the Government mooted a proposal to allow insurance companies to tap the equity markets after operating for 5 years. Also, interestingly no private life insurance company in India has completed 10 years of operations and its noteworthy that of 23 life insurance companies in India, only 3 have managed to break even.

In our opinion, introduction of the IPO route for insurance companies, is a path for reducing and off-loading their promoter holdings. From an investment perspective, subscription to such IPOs would be a risky investment proposition since profit margins of most private life insurance companies may come under pressure on account of the changed structure (with effect from September 1, 2010) of Unit-Linked Insurance Plans (ULIPs), making them attractive for investors, but uncomfortable for life insurance companies.

Impact

The Government plans to cap interest rates on student education loan, thus making it more affordable to students. As per an official in the Finance Ministry, the interest rates on education loans offered by banks may be capped at 2% above their respective base rates.

Hence now under the base rate regime (where the base rate is 7.25% - 8.00%) the outgo for students will be lower. Prior to the base rate system coming into effect from July 1, 2010, banks use to offer education loan above the Base Prime Lending Rate (BPLR) (which was around 11%).

But, it appears that bank’s are not willing to go with the Government’s diktat, as a senior official of a leading public sector bank, expressing his dissent. He said, "Most banks are already giving a concession of around 50 basis points for select students, or those who get selected in top colleges in their respective streams". Moreover, banks also fear that defaults may rise further. The 21 public sector banks have a total outstanding education loan portfolio of Rs 34,192 crore as on March 31, 2010, up 24% from the previous year.

We believe that such a move if implemented will be in the long-term interest of students and will be in alignment with the Government’s agenda of improving social infrastructure with investments in education.

INTERVIEW

In an interview with the Economic Times, Mr. Michael Carapeit, ED and Global Head of Macquarie Capital, shared his view on the European debt crisis, India’s performance amongst emerging nations and the outlook for the markets in the second half of 2010.

On the European debt crisis, he believes that broadly, the economies will move into a positive territory. "There will always be pain and there will always be good times, regardless of market sentiment", he said. He explained this from an investment banking perspective, and said that there are lots of Merger & Acquisition (M&A) transactions happening right now in the financial institution space as also privatisation of infrastructure and utilities by the Government. He also mentioned that a falling Euro has seen many manufacturing firms across Europe becoming very competitive on a pricing basis than they were 18 months ago.

Mr. Carapeit also believes that, while not being totally immune to what is happening around the world, the Indian economy when compared to the other emerging markets, will perform very well on account of its domestic nature. He is of the opinion that the Indian economy will experience a growth 7% - 8% this year.

On the market outlook for the second half of 2010, he appeared cautiously optimistic. "Markets, broadly speaking, are better than what they were 12 months ago and will continue to get better. We will see continued volatility and people will take a conservative approach while managing their businesses", he said.

AND OTHER NEWS...

• Religare Enterprises Ltd. made its foray into the standardised branded gold coin market by launching a new product "Swarna Mudra". The company through its wholly owned subsidiary - Religare Bullion Limited will sell gold coins and bars to investors. The gold coins are manufactured and certified according to international standards by MMTC for 999 Quality Guarantee and will be available in denominations of 2, 5, 8 and 10 grams.

• Despite the present double-digit Wholesale Price Index (WPI) Inflation, Finance Secretary, Mr. Ashok Chawla is optimistic and expects it to lower to a "comfortable" level of 6% by end of December 2010. "I expect headline (WPI) inflation to come to around 6% by December, closer to Reserve Bank of India’s estimate", he said.

• Indian mutual fund houses plan to charge an exit fee on liquid plus funds from August 1, 2010 onwards, in order to preclude early redemption of investments. The exit fee for early redemption would be in the range of 0.1% to 0.5%. As per mutual fund industry officials, liquid plus funds with an average maturity of 100-110 days could have exit loads between 7-15 days, whereas more aggressive liquid plus funds with an average maturity of 120-140 days could have exit loads between 15-30 days.
  
  In our opinion, introduction of an exit fee on liquid plus funds, is intended to smoothen flows into such funds and reduce volatility in return, as a new norm to value debt securities with maturities of over 91 days on Mart-To-Market (MTM) basis kick in from August 1, 2010.

• According to Deloitte (a top consultancy firm), over the next five years India China and South Korea will maintain the top three rankings in global manufacturing competitiveness, while economies of Western Europe, Japan and US are expected to be less competitive in the same time frame.

• RBI is evaluating the idea of providing private banking licenses. The central bank is giving final touches to a discussion paper, prepared by Department of Banking Operations and Development, on banking licenses.

New Issues

• Axis Mutual Fund launched an open ended hybrid fund named "Axis Triple Advantage Fund". As per the offer document, the fund is mandated to invest 30% - 40% of the collected corpus in equity and equity related instrument (including derivatives), 30% - 40% in debt and money market instruments and the rest 20% - 30% in gold Exchange Traded Funds (ETFs).
  
  As per the offer document, the investment objective of the scheme is "to generate long term capital appreciation by investing in a diversified portfolio of equity and equity related instruments, fixed income instruments & gold exchange traded funds".
  
  The fund will benchmark its performance against a customised composite benchmark comprising of S&P CNX Nifty, Crisil Composite Bond Fund Index and INR price of gold.
  
  The New Fund Offer (NFO) is open for subscription from June 30, 2010 to July 29, 2010.