Ashutosh's Corner

Indian Monetary Policy Updates for Dec 2011

1. RBI kept CRR ratio and repo rate unchanged at 6.0% and 8.5%
2. Inflation (Nov WPI) declined from 9.73% to 9.11% in Oct but is way above RBI's year end target of 7%
3. RBI's credit growth target remain unchanged at 18%

RBI's Outlook
Due to high downside risks to growth and already moderating growth momentum further rate hikes may not be warranted. Hereon, monetary policy actions will respond to risk to growth

Risk to Growth
1. IIP growth turned negative from 2% in Sep to -5.1% in October 2011. Index of IIP was at 158.1 in October.
2. Manufacturing sector constitutes over 75% of IIP Index. Due to high interest rate and moderating demand scenario owing to high inflation, Manufacturing sector registered -6.0% growth in October.
3. Mining sector also registered de-growth by 5% due to current crackdown in mining sector. Lack of policy clarity and environmental clearances has impacted this sector
4. IIP Index was at 175.6 in Dec 2010 and at 193.1 in Mar 2011. Even though growth registered in 8 core sectors in Nov 2011 will show growth in IIP index in Nov 2011 but due to high base effect YoY numbers may look bad in Dec '11 to Jan '12 and we may even see contraction there.

Due to above substantial turnaround can be expected only in first quarter next year

10 Year G-Sec Yields

Before policy 10 yr G-sec yield which was around 8.5% corrected to 8.37%. This is positive for banks as no further provisioning will be required on AFS portfolio in Dec quarter

FOREIGN CURRENCY RISKS FOR CORPORATES

Firms generate capital either by issuing equity or by borrowing debt and then they invest the capital to gain ROI. In current economic environment, even if a company is not exposed to foreign currency directly still it may have risks associated with foreign currency.

Various currency risks to a corporate can be broadly categorized as
1. Transaction Risk - Impacts cash flows

This risk arises whenever payable or receivable is in foreign
currency. So risk will arise if company sells on credit or pays with
delay, normally credit period is upto 90 to 180 days. Movement in
exchange risk may result in exchange risk loss or gain for the
company unless the risk is hedged, which comes at its own cost.

2. Translation - No impact on cash flows

This is less obvious as it has indirect impact on the company's
balance sheet and market rating. If company has exposure in foreign
currency by way of receviables, payables, investments or otherwise
then it has to first translate that exposure in domestic currency
before consolidating it in domestic balance sheet. Same amount of
receivables say USD 1000 in year 1 will be transalated to INR 50,000
(@50) and in year 2 it could be INR 45,000 (@45). In this case Asset
reduced by INR 5000 or by 10% YoY due to translation (assuming other
remain constant). Similarly it can also impact Debt to Equity ratio
(A = D+E), which will increase the borrowing costs for the corporate.

3. Economic Risk - Impacts unkown cash flows

Consider company X in country A and company Y in country B. Now
depending on econominc developments in two countries, their exchange
rate compared to another country say C where Customer is located can
change favorable for company X and other way for company Y which
will make X's products competitive and will negatively impact
company Y's sales forecast from the region. This is what US - China
tiff is all about. China's has artifically pegged its exchage rate
to low levels so that its products remain competitive worldwide.
Though artificially depreciating the currency has its own impact on
an economy but that is a different discussion altogether.