RBI may take a pause by keeping policy rates unchanged

While WPI inflation moderated in November, core inflation as measured by non-food manufactured WPI inflation is still above the RBI's comfort level. This may make the central bank to take a pause after increasing repo, reverse repo and CRR rates 13 times since March 2010

The Reserve Bank of India (RBI) is most likely to keep policy rates unchanged at its meeting on 16th December, say economists. They feel that while wholesale price index (WPI) inflation has moderated in November, core inflation as measured by non-food manufactured WPI inflation, is still above the RBI’s comfort level and this may make the central bank to take a pause and keep repo, reverse repo and CRR rates unchanged.

“Given the balance between inflation and growth, we expect the RBI to hold the policy interest rate steady over the remaining months of the current fiscal. We think cuts in the repo rate could begin in mid-2012. We assign only a small probability to an easing in the repo rate before second quarter of 2012, unless there is a major deterioration in global economic and financial market conditions,” said Barclays Capital in a note.

In October, the RBI, for 13th time since March 2010, increased repo (the rate at which the RBI lends money to banks) and reverse repo (the rate at which the RBI borrows from banks) rates by 25 basis points (bps) each to 8.5% and 7.5%, respectively to control inflation. The series of rate hikes has cumulatively increased interest rates by 525 bps in the last 20 months.

Expressing similar views, Goldman Sachs, in a research report, said, “While we continue to believe that sequentially falling inflation and much weaker growth will prompt the RBI ease monetary policy, our expectation of the sequence of easing remains first injecting liquidity through open market operations (OMOs), which the RBI has been doing, then cut the reserve requirement ratio of banks in January, followed by repo rate cuts in March 2012. As such, we assign only a 30% probability to a cash reserve ratio cut on 16th December. We continue to expect the RBI to cut policy rates by an above-consensus 150 bps in 2012.”

WPI inflation moderated to 9.11% year-on-year (y-o-y) in November from 9.73% in October, slightly higher than market expectations due to sharp deceleration in food inflation and stable manufacturing inflation. However, non-food manufactured inflation (which the RBI refers as core inflation) increased in November to 7.9% from 7.6% in October due to an increase in the prices of metals (1.5% month-on-month or m-o-m), chemicals (0.4% m-o-m) and non-metal minerals (0.9% m-o-m).

For the week that ended on 3rd December, food inflation fell to a nearly four-year low at 4.35% reflecting a decline in prices of essential items like vegetables, onions, potatoes and wheat. Food inflation, as measured by the WPI, stood at 6.6% in the previous week. It was recorded at 10.78% in the corresponding period last year. This is the lowest rate of food inflation since the week ended 23 February 2008, when it stood at 4.28%.

A big headache for Indian policymakers at the moment is the unrelenting slide in the rupee. With the dollar in great demand and macro-economic fundamentals weak, the pressure is likely to continue on the Indian currency. Continued weakness in the currency is pushing up the cost of imports like edible oil, fuels and metals. For example, while the global crude oil prices rose by nearly 20% in November 2011 compared to a year earlier, the rupee price of oil shot up by around 40% due to currency depreciation.  

Although India is a relatively closed economy, the rupee is a pro-cyclical currency and cyclical challenges are likely to outweigh seasonal positives into first quarter of 2012. Analysts expect the rupee to weaken further due to growth concerns and capital outflows. “We expect little near-term relief for the trade deficit, as exports slow and the reduction in the import bill is limited by oil imports and investors’ huge appetite for gold. As such, we do not expect rupee strength to resume until economic expectations bottom out, spurring portfolio flows back into Indian markets,” said Standard Chartered Research in a note.

Recently, there has been much debate about whether the RBI should cut the cash reserve ratio (CRR). “The still-elevated November inflation rate will offset market pricing of immediate CRR cuts by the RBI, despite the lower lower-than-expected industrial production numbers, as well as tight liquidity conditions. We continue to expect the RBI to inject liquidity via OMOs and not via CRR cuts over the near term—until March 2012 under our base case—as CRR cuts would likely stoke inflation expectations, which are just beginning to fall,” added Barclays Capital.

The liquidity deficit in the banking system of Rs880 billion, well above the RBI’s comfort level of Rs600 billion has increased expectations of a CRR cut from its current level of 6%. According to Standard Chartered, the RBI will be in no hurry to signal a change in stance this week. “Following recent comments from the RBI that the CRR is also considered a monetary policy tool, a cut in the CRR appears unlikely. In terms of supporting banking-system liquidity, we expect the RBI to continue with its OMO. Any rate cuts will thus have to wait until second quarter of 2012 when WPI inflation cools to 6.5% to 7%,” Standard Chartered said in a report.
The government and the RBI have accepted that high interest rates may hurt the country’s growth prospects, but the apex bank has underlined that bringing inflation under control is its major agenda.

The fall in food inflation comes as a silver lining for the government at a time when the economy is experiencing a slowdown, with GDP growth dipping to 6.9% in the second quarter, the lowest rate of expansion in over two years. Industrial production has also witnessed a contraction, with output shrinking by 5.1% in October. Headline inflation, which also factors in manufactured items, has been above the 9% mark since December 2010.

The RBI has hiked interest rates 13 times since March 2010 to tame demand and curb inflation. In its second quarterly review of the monetary policy in October, the central bank had said it expects inflation to remain elevated till December on account of the demand-supply mismatch before moderating to 7% by March next year.


If credit rating agencies are indispensable, can they at least be made accountable for their actions?

There is a need to regulate Indian credit rating agencies not only to make them accountable for their actions, but also to pre-empt any possibility of a ‘cash-for-rating’ scam, which can be prevented only if a strong regulation is put in place

If there is one business in this world that is minting money without being accountable, responsible or answerable to any one, it is the business of credit rating. Whether the economy is in good shape or bad, whether companies are making profits or not, whether investors are earning or losing money, the rating companies are there to make money for themselves, thanks to the wise men in power all over the world, who have given them unfettered freedom to say what they want, without any accountability for their actions.

Otherwise how do you reconcile to the fact that different rating agencies give diametrically opposite rating to the same country, same product, or same sector with same facts and figures. In the first week of August 2011, Standard & Poor’s (S&P), a global rating agency downgraded United States’ sovereign rating by one notch from ‘AAA’ to ‘AA+’ and millions of investors all over the world lost billions of dollars for no fault of theirs. Around the same time, two other international rating agencies, namely Moody’s Investors Service and Fitch Ratings affirmed triple A (AAA) rating of the US government based on the same data, same facts and same figures.

Nearer home, on 9 November 2011, Moody’s Investors Service downgraded India’s banking sector to ‘negative’ from ‘stable’, creating ripples not only in the capital market but also in the corridors of power in our country. But strangely, on the very next day, S&P upgraded the country’s banking sector from group ‘6’ to group ‘5’, citing “high level of stability,  core customers’ deposits, which limit dependence on external borrowings, and that Indian government is highly supportive of the banking system.” Curiously, within a week thereafter, another rating agency, namely Brickwork Ratings has maintained a “stable” outlook for the Indian banking sector based on “rational view of past performance of the banking industry, the positives and the challenges faced by banks, the regulatory environment and the implications of the Euro zone crisis”      
The three rating agencies have given three different ratings for our banking sector all at the same time, based on the same facts and figures, which proves how subjective is the rating system and how much reliable is the rating mechanism, causing a sense of concern among the people of this country.      
There is more to rating than meets the eye. On 11th November this year, S&P committed a blunder by accidentally sending messages to some of its subscribers that it had lowered France’s Triple A sovereign rating. Fortunately this mistake happened just after the Paris bourse had closed and that saved the day for the French investors from a catastrophe. Within two hours, the agency sent out another message saying that it was a technical error and that the rating of the French Republic was unchanged and continued to be Triple A. In the wake of this goof-up, the European Union Internal Market Commissioner had called for a rigorous, strict and solid regulation for credit rating agencies.

During the global financial crisis of 2008, the agencies admitted that they did make mistakes in their ratings, which partly led to the crisis and caused the collapse of the world markets then. The rating agencies gave their best ratings to borrowers before the housing crisis in America. It turned out that many were not able to pay their debts back, resulting in failure of renowned housing finance companies there.

Are the rating agencies indispensable? Over a period of time, rating agencies have become a part and parcel of the economy of the developed and developing countries—either by design or by default. They are expected to perform certain useful but onerous functions like educating investors in the art of investment, protecting the interests of gullible consumers, guiding industries to raise capital and most importantly serve as a guardian of the country’s economy by periodically emitting appropriate signals as to where the economy is headed during both good and bad times for the benefit of the people of the country and of the world, as well. But recent developments all over the world show that these rating agencies are not infallible. Being manned by human beings they make not only mistakes but blunders, too. Hence there is a need to make them accountable, responsible and answerable for their actions and their activities need to be monitored, guided and supervised so that they do the job expected of them objectively with a sense of purpose and great responsibility towards the people whom they are supposed to serve. Following the financial crisis of 2008, the Obama administration quickly enacted a law called Dodd-Frank Wall Street Reform & Consumer Protection Act on 21 July 2010. It is an omnibus law with an aim to create a sound economic foundation to grow jobs, protect consumers and investors, rein in Wall Street and big bonuses, end bailouts of too-big-to-fail, and prevent another financial crisis.

While the Act was touted as the most sweeping change to financial regulation in the US since the great depression, it contains several provisions to protect investors by codifying new rules for transparency and accountability of credit rating agencies, as well. The Act provides for creation of Office of Credit Ratings (OCR) within the Securities and Exchange Commission (SEC) to ensure oversight over Nationally Recognized Statistical Rating Organizations and enhanced regulation of such entities.

There are 76 rating agencies globally in different countries with 10 rating agencies (eight of US, one each of Canada and Japan) approved by the SEC. The big three rating agencies are S&P with ratings revenue of $1.70 billion, Moody’s Investor Services with revenue of $1.47 billion and Fitch Ratings with a revenue of $554 million for the year 2010. Seven other agencies have combined revenue of $196 million, as reported in the media. 
In India there are seven rating agencies at present, which are approved by different authorities and different wings of the central government, depending upon the rating work they undertake. At present, those agencies active in the capital market are approved by the Securities and Exchange Board of India (SEBI), those which are active in rating of bank loans, etc are approved by the Reserve Bank of India (RBI), and others by NABARD, National Housing Bank and by different ministries of the government. However, there are no uniform rules for such approval, nor is there any co-ordination between different authorities to ensure that the rating agency approved by them has the requisite competence to do the job expected of them. To streamline the entire operations of rating agencies and to keep track of the new rating companies coming into India, it is necessary to put in place a regulatory mechanism through a suitable enactment as early as possible. Here are a few important steps required to be initiated by the government in the interest of safeguarding the integrity of the securities market in our country.          
1    There must be an independent regulator for the rating agencies, who should formulate rules and regulations for centralized registration, reporting, monitoring and ethical functioning of all the rating agencies in the country. And all other regulators should go by such registration, instead of doing registration independently.

2    The rating agencies should have complete transparency in their operations, and periodical reporting of all aspects of rating to the regulator should be made mandatory.

3    The rating agencies’ promoters, directors and the top management should be screened by the regulator for their credentials, competence and their antecedents to ensure that only the deserving and competent people run this business.

4    Only by putting your money where your mouth is you can be made accountable for your actions. For this reason, the government should set up a Bondholders’ Protection Fund (BPF) to compensate certain type of investors (like senior citizens, etc) in rated bonds, debentures, etc. when there is a default by the issuers. The rating agencies should contribute funds to this BPF on a pre-determined ratio, and such a fund should be managed independently by trustees appointed by the regulator. The detailed mechanism of managing the fund can be decided by the regulator.

5.    The rating agencies should mandatorily communicate to the investors holding the rated bonds, whenever they downgrade an issuer or the bonds concerned, thereby helping the investor to take a decision to hold or sell the bonds and thus protect their interest.
6.    The regulator should put a cap on the fees charged by the rating agencies, and the fees charged for each rating should form part and parcel of the rating report to ensure transparency in their dealings.

7.    Every rating agency should set up a separate independent rating committee, whose members should not only be experts in the respective fields, but should not have any pecuniary relationship either with the rating agency or the issuer concerned whose instruments are rated in order to ensure that there is no conflict of interest.

8.    There should be complete ‘Chinese walls’ between the rating activity and non-rating activity handled by the agency and any non-rating business handled by the agency for a client should be clearly mentioned in the rating report on the said client.

9.    Whenever the rating agency downgrades an issuer or a bond, it should be given enough publicity in the national dailies with the largest circulation to serve as a communication to the general investors about the revised rating allotted to the issuer or the instrument.

10.    All rating agencies should publish their profit & loss account and balance sheet annually with all the data that goes along with the annual report. They should comply with all the requirements complied with by a listing company, like quarterly results, shareholding pattern, changes in directors, etc even though they are not listed, with a view to ensure transparency and better corporate governance.

11.    Every year a list of all companies and or instruments rated by them along with the periodical upgrade or downgrade affected by them should be published not only on their website, but also in leading national dailies in the month of April every year.

12.    The rating agencies that rate housing projects should certify the correctness of all claims and statements made by the builders after thorough verification and any variance observed by them should be communicated to the respective home buyers periodically.

13.    The rating agencies that rate educational institutions should be answerable to the students of the rated institutions for any variation in the claims and statements made by the managements of the institutions concerned.

14.    The regulator should have the authority to levy penalty for any wrong doing by the rating agency, including deregistration and winding up of the company, if so warranted.

15.    The regulator should periodically inspect the operations of the rating agencies to ensure that their operations are run on sound lines and that they are fit to continue to run the business of ratings.
16.     The rating agencies should lead by example whenever they rate a company for corporate governance, so that the standards followed by the rating company should form as a model for others to follow.

17.    The most important of all is that the aforesaid stipulations and any other conditionality felt necessary to regulate this business should be codified through a central enactment so that the business of rating grows on healthy lines and the public at large, investors and the consumers really benefit from their expertise and they in turn become more responsible and accountable to the society in which they operate.          
These are some of the broad contours of the proposed legislation to bring the rating agencies within the ambit of law, and the earlier it is done, the better it is for the economy. We have had several scams in our country recently. Two of them are cash-for-votes scam and cash-for-loans scam. It is time for us to take preventive steps to the extent possible to ensure that our country is free from any further scams, and to pre-empt any possibility of cash-for-rating scam, the government should initiate the steps suggested above early.

 (The author is a banking and financial consultant. He writes for Moneylife under the pen-name ‘Gurpur’)



Pop Rating House

4 years ago

Everybody may shows his credit rating expertise posting his analysis on the Pop Rating House facebook page

Nagesh Kini FCA

6 years ago

The raters also need to be regulated. On the international plane by OECD or UN agency and not IMF or WB who are perceived to be US bodies.
Imagine in the case of rating US they goofed by trillions of $ and got away y with a knock on knuckles from the US President.
In India two gave contrary ratings in the case of Indian banks where also they seem to have blundered badly.

Since lay people perceive Rating Agencies to be greater than God, their Reports on Indian entities need to be submitted to Indian Regulators for vetting, more particularly when they have been to be deficient in delivery.

R Balakrishnan

6 years ago

With all these caveats, no one would want to be in the ratings business. Ratings are like journalism. The moment you say that these kind of rules apply to journalism or an investment advisor, they will stop this business.
Ratings are opinions and if the world wants to use it as a convenient way to pass the buck, it is not the rating agencies' fault. Only because investors do not do their work or are incapable of doing so, do rating agencies exist.
we can use them as an assist, but holding them accountable for all their views would be unfair.
Yes, if they are fraudulent or dishonest, do so. But, if their views are an issue of competence or perception, why bother?
Do investors want iron clad guarantees on everything?
Rating business is a complex one and a regulator has to be more competent than a rating agency to regulate one. Yes, there can be a code of conduct, but if you have a regulator poking their nose in to matters which they do not understand, too bad.
What about the fund managers who did not do any homework on their own, but blindly depended on rating agencies?
A rating is only a supplementary tool for a decision and cannot be a primary one. The professional investors should be able to justify why they put money in to complex instruments without understanding anything themselves and then conveniently putting the blame on rating agencies.



In Reply to R Balakrishnan 6 years ago

I agree...

The public at large is too lazy to do its homework. It is always looking for scapegoats to pass the buck of their own inefficiencies.

Nirmal Kotecha: On the run?

Why can’t investigative agencies find him?

On 8th December, as this column goes to print, the Income-Tax Department (ITD) and the Enforcement Directorate (ED) were both hunting for controversial stockbroker Nirmal Kotecha.

Is the noose finally tightening around Nirmal Kotecha whose name has often figured in stock market manipulations? Sources who knew him well say that he frequently...

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