Tuesday, July 26, 2011

Repo Rate

The Reserve Bank of India (RBI) hiked its key policy rates, repo and reverse repo, by 50 basis points each. The rate hike was sort of a shock for the street, which was expecting the regulator to hike rates by 25 bps. The rate hike has taken the repo rate to 8% and the reverse repo has touched 7%. However, it has kept the cash reserve ratio (CRR) unchanged at 6%.
Speaking to CNBC-TV18, Koushik Chatterjee, Group CFO, Tata Steel said that it’s important to have a much more concerted effort than just a rate hike if we don’t want to get into a growth paralysis in India.
From the investment point of view, he feels that India still remains very attractive structurally for long-term investment decisions. However, he added that the trend of constant rate hike may hurt long-term funding if it continues for the next year or so.
Below is a verbatim transcript of his interview. Also watch the accompanying video.
Q: What is your key takeaway of this 50 basis points hike? Do you think it will already start hurting investment decisions?
A: There is a general trend across all central banks and that is towards policy experimentation in the absence of a much weaker underlying real economy especially in Western Europe and in developed countries. We also see that this is also very profoundly manifesting in India. The governor said that if the supply side and the other policy issues are not addressed at the government level, then the Reserve Bank is going to use one stick, which is its monetary policy stick to continue to beat and manage expectations of inflation.
I am not sure whether that will reach the final outcome because it requires an orchestra to make a good music and not one instrument and therefore, I think it’s important to have a much more concerted effort if we don’t want to get into a growth paralysis in India. It’s not so severe at this point of time. However, experimenting with policy makes it severe at point when it becomes very difficult to go the reverse side and therefore, while we can move on one direction, if it gets into a certain level and then you look at stimulus, which is coming out from government to reverse the growth reduction.
So it’s perhaps the only tool available to RBI at this point of time to fight inflation, which is important. However, it is a very alarming signal as to which way our policy is going to grow in India and we see this trend across the globe whereas in the US or in Europe.
Q: My short point is, will your own investment decisions change now or do you think that even with this kind of a rate level investment decisions are not going to hurt, only consumption will slow?
A: From a long-term investment decisions, India still remains very attractive structurally and it will continue to happen on that basis. What would happen effectively is with the real cost of capital increasing. The key thing for corporates would be to look at capital productivity. But otherwise, structurally the investments will happen at a higher cost of capital.
It may put the trade off between the cost of capital in India versus other emerging economies or developed economies. The gap will widen if this is the only trend that continues. But I don’t think structurally anything will be affected in the near-term. The consumption will certainly get affected and therefore, at a point you may have in different industries concerns on capacity if we do not ensure that the consumption levels remain buoyant.
Q: Have you already seen a fall in steel demand in this month vis-à-vis last month, do you expect it to be less in the coming month because consumption is quite clearly being targeted?
A: No, I don’t think we have seen anything to that in the last month and I don’t see that will be very profound going forward. This is also important to understand that there are some sectors like rural sector, which are not so very much affected by these kinds of policy implications.
There would be certain impact to have if the lending rates increase on consumer goods, but I don’t see this happening immediately. I haven’t seen this happening in the past. You may possibly ask people from the producers of consumer goods as to how they see it because as far as steel is concerned, I haven’t seen this in the last month, month and a half.
Q: When would you see red, when say the 10 year goes above 8.5% or when you own borrowing rates goes what above 11%, what is it now?
A: My average cost of capital is more reflective of around 11-12%. But if you really look at 10 year rates, the borrowing rates are still are at about 10%. I would certainly see red if the cost of capital on a trend basis continues to increase because that will put a lot more pressure on the return investor capital going forward.
I keep going back to the point on capital productivity, which is very important to understand a overall context because what I heard from the government is that this process will continue till there is significant down trend in inflation numbers. So, there is no sealing. I think it may hurt a long-term funding if it continues in this trend in the next year or so.
Q: So would not consumption or would not demand get impacted sooner other than later?
A: We haven’t seen it but as I said if we continue to increase policy rates in a secular manner, then it will certainly slowdown the entire economy. And when that happens, the ones which are more rate sensitives and customers in that particular sector will face lower demand, which will consequently go into sectors like steel, which will also slowdown.
The point here is that the investment decisions are not immediately getting affected primarily because we still believe that structurally India is the right destination to produce more and more steel. India today imports a lot of steel too. So I think I would put it into two specific baskets, one that the consumption will slowdown because of the fact that it will be difficult for people to perhaps look at buying cars as an attractive proposition or to build a house or build a residential properties and so on.
The other point is that India still needs those investments in the long-term and therefore, India will still remain as a destination for an attractive project and I think here is where the government can play a significant role and address the concern that the governor seems to have, which is that it needs to get onto more policy decisions and ensure that the consumption levels and the investment levels continue to increase.
I think this is where India has a special role because it was unaffected by the crisis. It should not get into crisis by taking policy decisions and it is a very important parameter for the government to watch for because we need more investments in all sectors including power, steel and other manufacturing entities. So I said that we haven’t seen any influence on the steel prices or the steel consumption in the last one month. However, there is no guarantee that there won’t be such influence going forward if the policy continues to be in this direction.