The one thing that is constant is change.

In business it’s very difficult to keep up with changes. And the pace at which things have changed is amazing. Be it products, service or technology, ‘change’ is the name of the game. So it’s upon us to capitalise on the changes around us. Accept them in the right way, and there is a definite benefit for you. I would like to share, the opportunities which you all could really capitalise on; and some challenges and problems which we need to address.

First, lets talk about the opportunities.



The Big Opportunity in Equity

You must've seen India and China; the global powers are shifting from developed markets to developing markets to India. In China 11% of population invests equities and in Korea it is 10%; but at our end, its only slightly higher than 1%. We have only 1 crore DP accounts. These are likely to go up to 5 crores in the upcoming years. But even then that will be only a small part of the 120 crore bank accounts we will have in the country by 2020. In the upcoming years there is a huge amount of new people who would be investing into equities.
Target the equity growth opportunity aggressively.


The Intermediation Opportunity

If you look at the broking business size; in 2009-10 Rs11700 crores of brokerage was generated. Now, the big picture -10 years down the line, the annual brokerage is estimated to be Rs 65000 crores. There is huge growth expected in mutual funds distribution commissions and insurance distribution commissions as well. The goal you set for yourselves in terms of share of this kitty is very critical. Even if you want to target 0.1 percent of the brokerage kitty, it would be 65 crores! I will not be surprised if the above growth estimates are surpassed.
The equity broking business will be big business!


The Market is 10 times bigger than you think it is

We have been talking about thinking big. And it’s going to be much bigger in future. The future will be different from the past. If you don’t think big; you will be redundant. So the first thing is to stop being pessimistic about growth prospects. Plan and think big. Keep on thinking about growth as an opportunity. Are you planning for the next 3-5 years when you invest in technologies or processes? Right now, our corporate office is 15000 sq. feet. We are talking about a 250000 sq. feet office next year. Are you planning big too? With every opportunity comes a challenge as well.
Now let’s outline the challenges and some proactive measures we can take.


Maintaining Strong Client Relationships

If you think the current market is competitive; you haven’t seen anything yet. Everyone is looking to profit from the India growth story. Competition will intensify with new players and consolidation. Your current customer is also someone else’s future prospect. You need to bulletproof your existing relationships so that business from your current customers grows and thrives. Profile your existing customers – are they Investors or Traders, find out about their financial goals - what is their investible corpus, what is their risk appetite, what are their returns expectations. Once you have this vital insight; you will be better equipped to go about fulfilling their needs. The more a customer believes you understand his needs; the more business he will give you. Organic growth from current customers is one of the most efficient ways to grow your business
Do you have an organic growth strategy?

Finance minister, Pranab Mukherjee, sounded a confident note time and again this year that GDP growth would be 8.5% (and trending towards 9%), inflation would be down to 6% and the fiscal deficit — the gap between government expenditure and revenues before borrowings — would be well within the 5.5% targeted for the year. The numbers at least till the second quarter of this financial year suggests the economy is on course to achieve the projections. Monsoons were good. All that’s good news. Not because, everybody knew it, but in a world that is still worried about slow growth and the possibility of another downward spiral, India stands out like a beacon of robust optimism.
Given this forecast, there is a good chance that the government will be able to wind down the economic stimulus package of 2008-09 by the next budget as the growth impulses of the economy are holding up. It will also prepare the country for the next round of reforms like GST, Direct tax, Retail and Insurance. Honestly, the growth is already a bit too robust. The country is growing so fast that it is importing far too much. At last count, the current account deficit — the gap between imports and exports of goods and services that has to be bridged with capital flows — is well above 3% of GDP, and maybe even 3.5%. This is clearly unsustainable, and sooner or later the country will have to reduce this deficit by slowing down growth or increasing exports. The latter appears dicey in the current global environment, though not absolutely impossible.
At a 3-3.5% current account deficit, India needs foreigners to invest in India, and in all probability, there would not be any restraint of dollar inflows into the stock markets. However, foreign investor inflows have already crossed $29 billion and are heating up the bourses and which is rapidly feeding into other markets like real estate and gold. It is difficult to see how this is a good thing, since it can lead to externally-induced market and economic volatility. In May, when the Greek tragedy unfolded and the FIIs suddenly withdrew money, the markets keeled over. There’s no point holding economic sentiment hostage to hot money flows.
Given the fact, that the fiscal deficit has been bridged largely by one-time earnings like spectrum revenues and public sector IPOs, it is best to let the markets and the economy cool off a bit. But, clearly, we have many things going for us. A strong consumption-led growth surge, a reasonable social inclusion package that is giving the economy a fillip of its own, and buoyant tax revenues are some of them. The only thing that can ruin it all is bad politics and scams— of which there is plenty to go around. We will do fine as long as we don’t shoot ourselves in the foot.
Two years after the global financial crisis, the developed countries deal with the problem their way. US hopes to spend its way out of slowdown while Europe decides to cut costs and resort to austerity. Quantitative easing in the US has brought a flood of liquidity to Indian equity markets also as is evident from the $29 billion that has come by way of portfolio investments this year. The inflation that is supposed to happen in US due to Quantitative Easing is not happening there but it is happening everywhere in emerging markets and India is no exception. The FII and FDI dollars are inflating the Stock and Commodity Prices stroking the inflation in India. The biggest problem thrown up by capital flows is currency appreciation, which erodes export competitiveness. Intervention in the forex market to prevent appreciation entails costs. If the resultant liquidity is left unsterilised, it fuels inflationary pressures. If the resultant liquidity is sterilized, it puts upward pressure on interest rates which, apart from hurting competitiveness, also encourages further flows. The Indian rupee has appreciated by nearly 3.3% against the USD this year on the back of inflows of over $39 billion that has come through the FDI and portfolio route.In that context, it must be said that India has done relatively well in sterilising the impact of reserves growth on their domestic financial systems and preventing asset price bubbles so far.

Indian markets have done well in calendar year 2010. The Bombay Sensitive Index has returned 14.4% till date and Indian markets have outperformed developed markets for two years in a row. The performance gap between the narrow and broad market closed out in 2010 as compared with 2008 and 2009. Both the indices achieved comparable returns this year.

Technology and Telecoms were the best- and worst-performing sectors for the year. Financials did well. Sector rotation was higher than average. Consumer discretionary, technology and financials were market outperformers, while utilities, energy and materials were underperformers. Industrials delivered the most volatile performance during this year. There were many money making ideas in both the large cap and the midcap space all through this calendar year. Midcaps saw a correction of 25-40% in the 4th quarter this year making their valuations much more attractive.
I remain constructive on the market outlook for 2011. The strong economic fundamentals, reasonable earnings outlook and lower valuations are likely to provide downward support to the Indian equity markets in 2011. The fundamentals of the Indian economy remain strong, while the capex cycle is yet to pick up substantially. The outlook for growth in earnings remains reasonable and the recent market corrections have made valuations a bit more reasonable. Financials, Industrials, Commodities and real estate are expected to do better than consumer discretionary and consumer staples in CY2011. Midcaps would give better returns than large caps next year.
The key concern area in my view would be any shocks emanating from the developed world or the high domestic inflation. Notwithstanding, some positive signs on the economic front in the western world, the debt levels do remain high. I expect some more bad news coming out of Europe in the first quarter of 2011. On the domestic side, while inflation is expected to come down over the next 3-4 months, higher commodity prices or sticky manufacturing prices would be an area to watch out for.
Volatility is likely to continue in 2011 with the central bank fight against inflation keeping the markets guessing on the extent of further tightening. However, with the effective front loaded tightening by the central bank, market yields are already discounting a fair bit of inflation worries and more importantly real rates are finally moving into positive territory, I believe that returns from markets are likely to be attractive for investors with a medium term horizon. At current levels ours is an interesting bottom –up market. These are times to buy the growth companies managed by great managements, especially in BFSI, Auto, IT, metals and engineering sectors.

GDP growth of 8.9% in 2QFY11 is a resounding validation of the India growth story. India has effectively endured a global crisis and the worst drought in 30 years. It continues to be one of the fastest growing economies – its GDP is likely to grow at ~9% in FY11 and well into FY12. Growth should rise to double digits, on track with the higher growth trajectory of the last decade. In short, India is well on its way to the next trillion dollars of GDP.

We published our first note on the concept of NTD (next trillion dollars of India's GDP) in 2007. The core NTD thesis is this: It took India about 60 years post independence to clock the first trillion dollars of GDP. With nominal GDP growth of 14-15%, at constant exchange rates, India's next trillion dollars (NTD) will come in just 5-7 years. We juxtapose the NTD idea with the GDP growth experience of China to arrive at India's GDP of almost US$5 trillion by 2020.

The addition of the next trillion dollars to India’s GDP has exponential growth implications for several businesses. Consider this: India's current gross domestic saving is at 34% of GDP. In line with long-term trend, we expect this to rise steadily to 40% by 2020. This translates to cumulative decadal saving of over US$10 trillion, compared to US$2.7 trillion during the decade to 2010. The large savings pool presents a huge opportunity for many businesses. Applying a trended growth rate correlated to GDP, in the decade to 2020, business opportunity will be five times and profits six times the previous decade.

India enjoys a special demographic advantage. With over 200 million households, India is not only a huge consumer market but also an attractive investment destination. Its consumer market is projected to become the fifth largest by 2025, worth more than US$1,500 billion. India’s total commerce, which was estimated at US$2.3 trillion in 2007, is expected to triple by 2025, making it larger than the current size of the UK market in terms of purchasing power parity. India might well be at the helm of a radical realignment of the global economy!

However, the journey is unlikely to be smooth – a number of speed-breakers and roadblocks will be encountered along the way. The fallout of the lack of radical reforms has shown up in high consumer inflation, which though trending down, continues to persist. Rising global commodity ( including oil )prices are adding further fuel to the fire. Interest rates are headed up. The speed with which India’s reforms process is progressing is less than desirable. Adapting to changes in global economic trends and their impact – wild gyrations in exchange rates, fight of capital, for instance – is becoming more challenging. Macroeconomic and business headwinds apart, markets have reason to be concerned about the serious and relentless issues of corporate and political governance, which India is currently embroiled in.

A serious challenge that faces India is ensuring that the fruits of progress are not restricted to just a few. The bottom one-third of India’s 1-billion-plus population still lives below a contentiously-defined "poverty line". It is this section of the population that is most impacted by inflation. Even basic healthcare and education is not available to a large section of the population. The prevailing economic and social inequality is already fuelling social unrest and insurgencies in various pockets of the country. If there is further increase in the rich-poor divide, it could fuel further discontentment and prove to be disruptive. Besides the threat of internal conflicts, it is equally important for India to be adequately prepared for possible external aggression. Relations with neighboring countries, especially Pakistan and China, need to be effectively managed.

The government’s attempts to reach out to the poor are proving to be ineffective. Subsidies do not reach the people they are targeted at. For instance, kerosene is under-priced because it is supposed to be used by the poor for cooking and lighting and also aimed at discouraging the use of wood for burning. However, it is illegally diverted to adulterate diesel and petrol because of price differentials and is smuggled out of the country. Similarly, diesel prices have still not been fully deregulated due to the direct impact of higher diesel prices on inflation. Diesel is used to power generator sets used in irrigation and to fuel trucks that carry agricultural products, raw material and finished products. However, the unintended beneficiaries are owners of luxury cars and SUVs, who can do without the fuel subsidy.

India levies high taxes on petroleum products – half of the selling price of petrol and nearly a third of the price paid by consumers of diesel goes towards various imposts levied by the state and central governments. However, instead of paring taxes on petroleum products, the government has chosen to shift the burden on to consumers. I am not saying that I am opposed to fuel price deregulation or that I would like auto fuel subsidies to continue. High petro-product subsidies have a negative impact on India’s fiscal health, which too eventually culminates in higher inflation. I am merely implying that a more holistic approach to fuel pricing – including the possibility of lower imposts on petro products – is necessary in India’s context.

It is necessary that the government’s thrust on infrastructure development continues. While projects such as the Golden Quadrilateral and the North-South and East-West corridors are laudable, sustenance of India’s growth story will depend to a large extent on continued investment in infrastructure. Also, several regional biases have crept up in the years following India’s independence. There are pockets that have not flourished as much as the rest of the country – the North-East states and the BIMARU states, for instance.

Even in the more progressive states, development expenditure has been concentrated in a few urban centers. This is evident in the stark difference between the city of Mumbai and the rest of Maharashtra. Lop-sided development comes with its own set of social issues – one that makes regular news is the issue of migrant labor. Looking at human resources in general, while India’s educated population is sizeable, the industry often complains about acute skill shortage. Education and training is an area where much needs to be done.

Food security is another issue that India needs to wake up to. While India is agriculturally well-endowed, 60% of its total cropped area is not irrigated and dependent on a four month-long monsoon during which period 80% of the year's total precipitation takes place. In the years when the monsoon is abundant and regular, there is good crop output. But when the monsoon plays truant or is inadequate, the crop output is poor. There is a need to develop extensive irrigation infrastructure throughout the country. Policies relating to agricultural produce – fertilizer subsidy, administered pricing mechanism, public distribution system – need to be re-examined.

One roadblock that India needs to demolish quickly is rampant corruption. Serious and relentless issues of corporate and political governance have been coming to light. Such brazen acts of corruption are a big deterrent to national prosperity and can damage the brand India story. However, there appear to be no serious deterrents to corruption, which often goes unpunished. While India needs a total overhaul of its anti-corruption delivery system, it is even more important to revamp the education system. Without a holistic education system, India’s greatest strength – its army of young people – could turn out to be its greatest weakness!

The Indian economy is no longer at the crossroads; rather, it is on the right path to sustainable growth. GDP growth of 8.9% in 2QFY11 is a resounding validation of the India growth story – it has effectively endured a global crisis and the worst drought in 30 years. India continues to be one of the fastest growing economies in the world – its GDP is likely to grow at ~9% in FY11 and well into FY12. Growth should rise to double digits, on track with the higher growth trajectory of the last decade. However, the journey is unlikely to be smooth.

The fallout of the lack of radical reforms has shown up in high consumer inflation, which though trending down, continues to persist. Rising global commodity prices are adding further fuel to the fire. Interest rates are headed up. The speed with which India’s reforms process is progressing is less than desirable. Macroeconomic and business headwinds apart, markets have reason to be concerned about the serious and relentless issues of corporate and political governance, which India is currently embroiled in. While it will continue to encounter speed-breakers and roadblocks, India is well on its way to the next trillion dollars of GDP.

We published our first note on the concept of NTD (next trillion dollars of India's GDP) in 2007. The core NTD thesis is this: It took India about 60 years post independence to clock the first trillion dollars of GDP. With nominal GDP growth of 14-15%, at constant exchange rates, India's next trillion dollars (NTD) will come in just 5-7 years. We juxtapose the NTD idea with the GDP growth experience of China to arrive at India's GDP of almost US$5 trillion by 2020.

As we have pointed out time and again, the addition of the next trillion dollars to India’s GDP has exponential growth implications for several businesses. Evidence of this is already springing up. Consider this: the number of passenger cars sold in October 2010 was 182,992, the highest ever in a calendar month in India’s history. The Society of Indian Automobile Manufacturers (SIAM) forecasts that passenger car sales for the year ending March 2011 should grow by at least 25%. The Indian passenger car market is likely to triple over the next decade to six million cars a year. It is no surprise, therefore, that India has turned into a major battleground for global vehicle manufacturers such as Ford, Renault-Nissan, General Motors and Volkswagen.

India enjoys a special demographic advantage. With over 200 million households, India is not only a huge consumer market but also an attractive investment destination. Its consumer market is projected to become the fifth largest by 2025, worth more than US$1,500 billion. India’s total commerce, which was estimated at US$2.3 trillion in 2007, is expected to triple by 2025, making it larger than the current size of the UK market in terms of purchasing power parity. India might well be at the helm of a radical realignment of the global economy!

Growth broad-based, expect FY11 GDP growth of 9%



India's 2QFY11 GDP growth at 8.9% (MOSL 9%, Consensus 8.2%) signifies (1) economy operating close to potential, and (2) resounding validation of the India growth story. While agriculture and services expectedly turned up, industry also performed well. Most importantly private consumption is back and the government is only gradually withdrawing its fiscal support. We expect GDP to grow at ~9% in FY11 and well into FY12.



Cyclical upturn drives GDP growth to ~9%, as expected

- 2QFY11 GDP growth was 8.9% (MOSL 9%, consensus 8.2%), which was in line with expectations.

- Simultaneously 1QFY11 GDP was revised to 8.9% from 8.8%. Thus 1HFY11 growth was a healthy 8.9%.

- The cyclical upturn has taken GDP close to the potential 9% and seems to have stabilized at that level.



All sectors and components of GDP do well

- Notably all three sectors of the GDP performed well.

- Agriculture (4.4%) turned up due to bumper Kharif harvest on the back of a good monsoon.

- Notwithstanding the sharp fluctuations in monthly IIP figures, industry posted a healthy 8.9% growth. This was driven by IIP growth of 15% in July, but it subsequently decelerated.

- Service sector grew by 9.8%, remaining close to double-digit level. The sub-group of trade, hotels, transport and communication, which constitutes nearly equivalent weight in the overall GDP as that of the industrial sector (including construction), registered 12.1% growth, perhaps receiving a boost from the Commonwealth Games. This is the only notable sub-sector that bucked the seasonal 2QFY11 downturn by a wide margin, pulling up overall GDP.

- The expenditure side of GDP revealed a noticeable turnaround for private consumption expenditure, even on a QoQ basis, which augurs well for future growth.

- The government has continued to support the economy, indicating it will spend the excess amount received from one-time 3G/BWA revenue and collections due to higher tax buoyancy.

- Investments slowed down, perhaps due to the monsoons delaying a few construction and project-related activities.



Expected growth close to 9% despite near-term setbacks

- We have revised our FY11 growth projections to 9% from 9.1%, led by a recent slowdown in IIP, which we hold is not yet conclusive due to data issues related to the indicator.

- Buoyancy in the agriculture and services sectors will continue, as indicated by the outlook for the Rabi crop and most lead indicators of service sector.

- The recent spate of governance issues (that have yet to significantly dent actual projects on ground) could dampen sentiment in the near term. However, the sheer volume of ongoing projects (~US$2.6t) could keep the investment story going for a long time. Some setback in the mining and electricity sectors notwithstanding, the industrial sector can still pull off high single-digit growth due to the revival of exports.

- A turnaround of private final consumption indicates the durables and FMCG sectors will do well. Moderation in inflation would help these industries to grow.

- Supplementary demands put up by the government to Parliament in two phases demonstrate that the government will not withdraw its fiscal support though it will contain it to pre-announced levels. This augurs well for consumption demand, as there has been a bulge in welfare payments, and for attracting private investment in the PPP format.

The start of the internet age redefined ways of conducting financial transactions including broking. The last few years have seen online trading in India develop and grow into a mature business with products being developed continuously and volumes stabilize.

Internet penetration is low in India with 45 mn internet users, while there are 127 mn mobile users capable of accessing data services through their handset, implying a 3x high-end mobile penetration. Once mobile trading is available, new investors who are deprived of internet connections as well as existing investors who can’t trade through wired internet will enter the market. Though most users of mobile trading may initially attempt to use it to have information at their finger tips increasingly customers would start conducting business through this medium.

Increasing smart phone penetration and availability of internet browser as a basic feature in entry-level phones is increasing the base of subscribers who can access internet. As of 2QFY10, ~127m subscribers were capable of accessing data services through mobile handsets. Non-voice revenue mix of Indian wireless operators remains low at 10-11% v/s 25-30% for mature markets due to non-availability of 3G services. Thus as these services become operational, we assume data mix to increase to 20 to 25% by 2015. Apart from mobile applications, 3G services will also allow GSM operators to offer mobile broadband services, which is a fast-growing market and has significant potential given negligible fixed-broadband penetration in India. 3G spectrum will provide telcos the opportunity to offer real time trading as well as interactive & real time equity research based services thus leading to increased revenues through subscription based research services as well as increased data usage

For a customer who wishes to avail the facility it is recommended to carry out few pre-checks. User should ensure that the GPRS is enabled by the service provider and that the handset supports the application/ portal. It would be key to note that the strength of the net connection plays an important role in user experience especially during travel, though most mobile sites/application take due consideration of this aspect in design.

The variety of mobile phone devices and the technology associated in terms of operating system, browsers and even screen sizes are the challenges faced by brokers and their software development partners. Technologies are now progressing to obtaining the handset information and then proactively provide the user best view. Mobile trading is an extension of traditional online trading and works either by use of a browser or an application provided by the broker. The internet speed on mobiles is far less as compared to computers thus limiting the design and features as compared to a web version of online trading.

Security of transactions executed pose complicated challenges which are addressed by the guidelines laid down by the regulators. Use of encryption, secure socket level security and time based password expiry are some of key technological initiative to secure the end users information and transactions.

At MOSL we have launched our browser based mobile trading system. We are gearing up to manage increased customer activity in the mobile space. All key trading activity such as viewing market watch, reports (orders, trades, net position, margin etc), placing and modification of orders, access to live advice are available on mobile for MOSL online customers. Alongside our launch we are collecting customer feedback and expectations which we will roll into our product development cycle.

Our continuous efforts will ensure our customers get the right experience and enjoy their trading journey with us.

There is a lot that independent India has achieved. From 1951 to date; our economy has grown from 21 billion dollars to 1.2 trillion dollars. That’s over 60 times in 60 years. From the 3-4% Hindu rate of growth in the pre-90s, India has transformed into one of the fastest growing economies in the world. What’s more; in the next 6-7 years this GDP will further double.

The opportunity today is ripe to achieve a different kind of freedom. Freedom that will help secure the future of ourselves and our loved ones. I call it FINANCIAL FREEDOM.

When it comes to achieving freedom there are no short cuts. Just as our country’s freedom was achieved through a concerted effort; so is financial freedom. It won’t happen in a day; but it will happen. What we need to do is follow some basic principles.

The first is to have a systematic and long term approach to investing. We need to review our risk profile and allocate our savings across different asset classes. As a country we save over 35 % of our GDP. But are we investing it judiciously? Most of the people are risk averse and hence put their full money in bank fixed deposits. While that may be safe but may not give your adequate returns which may not even cover the base inflation. Investing some portion of your money into equity as an asset class is very important. Since the inception of the Sensex in 1979; Indian stock markets have given around 17% annualized returns. `Rs 1 lac invested in the stock markets in 1979 would today be worth ` 1.3 crores. At a 12% rate of return; if you invest `11000 every month in a equity mutual fund through an SIP mode, it will be over ` 1 crore in just 20 years. That’s the power of compounding. If we take a long term perspective there is enough money to be made to achieve financial freedom. The trick lies in diversifying our investments, investing systematically; and over a period of time.

The second is the use of knowledge and expertise. We spend most of our time and effort earning money. And hardly any managing and growing it. The key to growing wealth lies in knowledge. Lack of knowledge means lack of understanding. And lack of understanding makes us oblivious to the myriad opportunities around us. Many of us are fearful of the complexity managing money brings .Managing money is not to be feared; but to be understood. It is only when we know more that we will fear less. And if we do not have the time or resources to understand how to manage money; do not feel shy to engage the services of a knowledgeable expert. Besides losing money; the biggest detriment to financial freedom is to let our wealth stagnate.

And lastly is the challenge of managing our emotions. A task easier said than done. From Dalal Street to Wall Street; ‘Greed’ and ‘Fear’ are two most powerful words which can make you lose a fortune. But as someone said “Be greedy when others are fearful; be fearful when others are greedy”. If you find yourself in market frenzy; go for a walk and cool down! Be rational in your approach - research before you invest; not after. And once you have done so; have the conviction to stick to your game plan.

We live today in exciting times. The Next Trillion Dollars of India’s GDP growth presents us a once in a lifetime opportunity for creating and growing wealth. 63 years ago; the founders of our nation helped us achieve freedom. Today; it’s time for us to achieve a different kind of freedom – FINANCIAL FREEDOM.

1. INDIAN ECONOMY: RBI RAISES POLICY RATES TO CONTROL INFLATION; WILL REVIEW POLICY TWICE A QUARTER

THE MEASURES
- Increase in the Repo rate by 25bps to 5.75% as per expectations.
- Increase in the Reverse Repo rate by 50 bps to 4.50% vs expectations of a 25bps hike.
- CRR has been left unchanged as expected.
- The FY11 GDP growth estimate has been enhanced by 50 bps to 8.5% (from 8% with an upward bias as per April Policy) as per expectations.
- Similarly the March 2011 inflation estimate has been enhanced by 50 bps to 6.0% (from 5.5% as per April Policy) as per expectations.
- No extension granted to the daily second LAF facility as per expectations.
- Monetary stance is substantially altered to give ascendancy of inflation control in policy priority as per expectations.
- Although RBI has taken mid-course corrective actions in the past and retains the right to do so even now, somewhat unexpectedly, the RBI has increased the frequency of review of its policy to one and half months from a quarter at present.
RBI RAISED SHORT TERM LIQUIDITY MANAGEMENT RATES - BROADLY IN LINE WITH EXPECTATIONS – MILD SURPRISE ON REVERSE REPO
RBI NOTED THAT THE MARKET MOVING IN THE REPO MODE ACTED AS ANAUTONOMOUS TIGHTENING OF MONETARY CONDITIONS BY 150 BASIS POINTS


RBI’S ASSESSMENT AND EXPLANATION
- Global growth and inflation has been multi speed. Visible soft spots in Europe and the US contrasts with relatively rapid recovery in EMEs accompanied by faster growth in prices. Global growth in the second half of 2010 will be lower than that in the first half. Global inflationary pressures are expected to be subdued over the next few months.
- On the domestic front, the recovery has consolidated and is becoming increasingly broad-based. The strength of the recovery is also reflected in the sales and profitability growth of the corporate sector. Besides replenishment of inventories, investment intentions are being translated into action across sectors, particularly in power, telecom and metals. However, if the global recovery slows down, it will affect all EMEs, including India, through the usual exports, financing and confidence channels.
- The recent partial deregulation and increase in administered prices of petroleum products is welcome from long-term fiscal consolidation and energy conservation perspective. Nevertheless, it will have an inflationary impact in the short term of 1% immediate impact followed by second round impacts in coming months.
- Food price inflation has remained at an elevated level for over a year now, reflecting structural bottlenecks in certain commodities such as pulses, milk and vegetables. The Reserve Bank’s quarterly inflation expectation survey conducted during the first fortnight of June 2010 indicates that short-term inflationary expectations have increased marginally.
- Notwithstanding the current inflation scenario, it is important to recognise that in the last decade (2000-01 to 2009-10), the average inflation rate, measured both in terms of WPI and CPI, moderated to around 5 per cent from the historical trend rate of about 7.5%. Against this backdrop, the conduct of monetary policy will continue to condition and contain perception of inflation in the range of 4.0-4.5%. This will be in line with the medium-term objective of 3.0% inflation consistent with India’s broader integration into the global economy.
- The main risk of RBI’s assessment emanates from the global scenario and has two key dimensions. First if the global recovery falters, the risk of which has increased since the April 2010 policy announcement, the performance of EMEs is likely to be adversely affected. The more significant risk, though, is from a potential slowdown in capital inflows. India’s rapid recovery has resulted in a widening of the current account deficit, as imports have grown faster than exports. Apart from narrowing the comfortable buffer between the current account deficit and net capital inflows, this may constrain domestic investment, which is critical to achieving and sustaining high growth rates.
- Current market conditions indicate that while liquidity pressures will ease, the system is likely to remain in deficit mode for now.
- There is no unique way to determine the appropriate width of the policy interest rate corridor. But the guiding principles are: (i) it should be broad enough not to unduly incentivise market participants to place their surplus funds with the central bank; (ii) it should not be so broad that it gives scope for greater interest rate volatility to distort the policy signal.
- Rough estimates show an improvement in the total flow of financial resources from banks, non-banks and external sources to the commercial sector during 1QFY11 (to Rs2,500 bn as against Rs610 bn during 1QFY10). Disaggregated data suggest that credit growth to all major sectors such as agriculture, industry, services and personal loans had begun to improve from November 2009 onwards.
- The 10-year benchmark government security fell to 7.59% in June 2010 from 8.01 per cent in April 2010 in the expectation that the Government will reduce market borrowing because of higher realisations from spectrum auctions. Subsequently, the yield moved up to 7.73% by the third week of July 2010. Of the budgeted net market borrowing of the Central Government for FY11 at Rs.3,450 bn, about 38.5% (Rs.1,329 bn) of the borrowing was completed by mid-July 2010.
- The foreign exchange market saw volatility increase relative to the previous quarter, with the rupee showing two-way movements in the range of Rs.44.33-Rs.47.57 per US dollar. During 1QFY11, both the nominal and real effective exchange rates (NEER and REER) have appreciated.


TAKEAWAYS FROM THE POLICY MEASURE AND RBI’S ASSESSMENT
- With the policy rate hikes, change in stance and the outline of liquidity conditions, the RBI has done its bit for inflation control. Importantly, RBI has reiterated its resolve to contain inflation perception in the range of 4.0-4.5% and the medium-term objective of 3% inflation set out earlier conducive to India’s integration with the global economy. The strong stance is important in view of the July inflation quoted (press reports) at 11% (as against our estimate of 10.2%) by India’s Chief Statistician Mr. T.C.A. Anant. RBI’s move is therefore imperative and is expected to anchor inflationary expectations at the margin.
- The reduction of the LAF corridor from 150 bps to 125 bps is attempted as an additional measure to contain volatility of short term rates and push the minimum rates up. The market being in repo mode and expected to be so for some time makes the measure more of a signal of anti inflationary resolve of RBI. The instrument, however, would become functional when the system returns to excess liquidity again or for those institutions that turns liquid faster than others.

RBI’s MEASURE IS TIMELY IN VIEW OF EXPECTED DOUBLE DIGIT INFLATION IN JULY


- The change in monetary stance of RBI is instructive. While interest rate regime has gained ascendancy in policy priority in lieu of liquidity management, short-term liquidity management would be in focus in place of ensuring adequate provision of liquidity for credit growth. In our view this is indicative of the shift in focus from short-term liquidity situation (which would continue to be actively managed) to long-term liquidity situation which might become stressful going forward.
CHANGES IN POLICY STANCE OF RBI – INTEREST RATE REGIME AND LIQUIDITY MANAGEMENT ALTERS POSITION, LIQUIDITY OBJECTIVE CHANGED MATERIALLY

Stance as per July 27 Policy	Stance as per April 20 Policy
Contain inflation and anchor inflationary expectations, while being prepared to respond to any further build-up of inflationary pressures.	Anchor inflation expectations, while being prepared to respond appropriately, swiftly and effectively to further build-up of inflationary pressures.
Maintain an interest rate regime consistent with price, output and financial stability.	Actively manage liquidity to ensure that the growth in demand for credit by both the private and public sectors is satisfied in a non-disruptive way.
Actively manage liquidity to ensure that it remains broadly in balance so that excess liquidity does not dilute the effectiveness of policy rate actions.	Maintain an interest rate regime consistent with price, output and financial stability.

- The combined impact on liquidity is therefore, much complicated. Short term rates have remained elevated for longer time than expected as the Government spending is being more staggered than expected. Although there has been some softening of money market rates in the past couple of days coupled with a lower recourse to RBI’s repo window (~Rs400bn against Rs600-700bn), this is yet to establish as a trend. Moreover, Central Government’s cash balances with RBI that has come down to Rs550bn from Rs700-800bn at end-June/early July matches with the recourse to repo window of RBI. Thus while liquidity situation may improve by August (possibly prompting RBI not to extend the second LAF facility), it is clear the system as a whole is not operating with any liquidity buffer.

THE FOCUS ON SHORT TERM LIQUIDTY MANAGEMENT TO CONTINUE


THERE HAS BEEN SOME MODERATION IN SHORT-TERM RATES RECENTLY ALTHOUGH YET TO ESTABLISH ITSELF AS A TREND


- It is likely that with the introduction of base rate, there would be greater competition among banks to lend acting as a barrier to push deposit rates down, lest it affects banks’ margin. A more likely scenario, however, is that the rapid expansion of credit market leaves banks’ with pricing power that can be used to increase deposit rates, albeit with a lag. The parallel initiative of financial inclusion (very significantly, RBI has allowed mobile banking now) may alleviate the banks’ liability constraints in the medium term.
- While capital flows so far has held up and the promise of near zero policy rates abroad for extended period of time indeed makes relative attractiveness of Indian growth a compelling proposition for capital inflow – evidently this would be volatile and partly would go to fund the higher current account deficit, itself a result of strong growth and import of capital goods.
- However, if none of the above holds, RBI would need to inject enduring liquidity through open market operation (OMO) to fund private credit growth – similar in the nature of liquidity infusion to fund heavy Government borrowing of FY10.
- Evidently, the contradiction of raising rates with continued liquidity support which may transform from repo balance to OMO for RBI provides a challenging outlook to monetary policy management till inflation abates on brighter prospect of monsoon, agriculture, international oil and metal prices, etc.

THE LIQUIDITY SITUATION TO EVEN OUT BETWEEN SURPLUS RISING CREDIT GROWTH CALLS FOR HIGHER DEPOSIT GROWTH GOVERNMENT AND DEFICIT BANKS AND PRIVATE SECTOR

RISING CREDIT GROWTH CALLS FOR HIGHER DEPOSIT GROWTH OR OMO FROM RBI OR HIGHER CAPITAL FLOWS FROM ABROAD                          


- Other things remaining same we expect continued rate hike upto 50 bps more during FY11 (raised from our earlier expectation of only 25 bps more) in view of the indication of further firming up of inflation in July.
- We continue to hold that softening of inflationary outlook in H2FY11 and reduced Government borrowing programme for H2FY11 would mitigate the market determined short term rates as the Government vacates the credit market for private sector growth. However, if capital flows aren’t adequate, the pressure on liquidity may permeate from longer term and would continue to ebb policy rates higher apart from RBI’s own push to control inflation. We still do not foresee policy rates meaningfully leading market rates to signal anti-inflationary stance. To that extent RBI has not forsaken the growth supportive stance altogether.
2. MONSOON UPDATE: Cumulative rainfall deficiency improves again to 5% on July 27: Outlook positive
- Overall rainfall deficiency in the country as a whole improved to 5% for the period June 1 to July 27.
- While temporal pattern of rainfall is improving rapidly, the spatial pattern shows that except the East & North-East, all other regions have recorded sharp improvement in rainfall recently.
- According to forecast by IMD, heavy rainfall activity would continue various parts of the country but concentrated on the west coast, western region and the northern-Himalayan region. The extended forecast up to August 1 predicts increased rainfall activity over central and north Peninsular India.
- The International Research Institute (IRI) for Climate and Society saw the possibility of heavy to very heavy rains in West and Northwest India. Thus more rains are expected for Gujarat, Rajasthan and Konkan even as south interior peninsula appears to have entered a phase of relative calm.
- According to the Japanese researchers (Japan Agency for Marine-Earth Science and Technology - Jamstec) a monsoon-friendly La Nina condition has been established rather quickly in the east equatorial Pacific Ocean in June itself.

RAINFALL UPTO JULY 27, 2010 (CUMULATIVE SINCE JUNE 1, 2010)
	Actual rainfall (mm)	% Departure from LPA
Country as a whole	396.2	-5%
North-West India	248.7	-3%
Central India	448.7	-1%
South Peninsula	391.7	11%
East and North-East India	575.3	-22%
Category	No. of Subdivisions	Range (% Dep from LPA)
Excess	8	21% to 80%
Normal	20	19% to -18%
Deficient	8	-20% to -45%
Scanty	0	-
Total Subdivisions	36	80% to -45%

PROGRESS OF MONSOON IN RECENT PERIOD (CUMULATIVE SINCE JUNE 1, 2010)
Category	18-Jul	19-Jul	20-Jul	21-Jul	22-Jul	23-Jul	24-Jul	25-Jul	26-Jul	27-Jul
Excess	5	4	4	5	7	9	10	9	8	8
Normal	18	18	20	21	19	17	16	18	21	20
Deficient	13	14	12	10	10	10	10	9	7	8
Scanty	0	0	0	0	0	0	0	0	0	0
Departure from LPA	-16%	-16%	-15%	-14%	-12%	-11%	-11%	-9%	-7%	-5%
Dispersion in LPA	83% to -56%	81% to -50%	82% to -50%	79% to -51%	80% to -51%	77% to -52%	71% to -51%	67% to -51%	64% to -47%	80% to -45%

HEAVY RAINFALL OFF LATE IS REDUCING THE CUMULATIVE DEFICIT OF THE SEASON

SHARP IMPROVEMENT IN RAINFALL IN NORTH-WEST AND CENTRAL REGIONS IS PULLING THE ALL-INDIA AVERAGE UP