Wednesday, April 18, 2012

Three cheers to RBI

IPL cheer leaders were seen doing a jig outside RBI yesterday and why not? In it's annual monetary policy announced on Tuesday, RBI took the market by surprise and cut rates by 50 bps.  RBI raised rates 13 times between March 2010 and  October 2011 in its struggle to contain inflation and in the bargain maiming economic growth which was at a meager 6.1% in quarter ended December 2011, it's slowest in three years. 

Policy highlights:
  • Repo rate was reduced from 8.5% to 8%, reverse repo is at 7% and CRR remains unchanged at 4.75%
  • Lower inflation figures in March and sharp fall in industrial production brought about the drastic change in RBI's stance from being cautious to reducing interest rates aggressively (twice of market expectation)
  • This move of RBI clearly indicates that focus has shifted to growth and would remain so as long as growth - inflation dynamics remain in the right direction
  • This somewhat sharp cut is to prod banks to swiftly transmit benefits to customers.  
  • RBI is comfortable with current liquidity conditions but is watchful and prepared to take necessary steps if and when warranted
  • RBI's Baseline expectation for GDP for FY 13 is 7.3% compared to projected 6.9% in FY 12 which just ended.  Headline inflation is expected to end the current year at 6.5%
  • RBI also underlined the need to decontrol diesel, LPG and kerosene prices despite risk of inflationary pressures.  This would cap subsidy burden and ease ballooning  fiscal deficit 
  • Central bank has proposed removal of foreclosure charges or prepayment penalties on home loans bearing floating interest rates.  Though some banks are following this already, this has now been formalised

So what's in it for us?  Imminent reduction in deposit and lending rates though reduction in home loan rates may not be immediate.  Reduced interest cost will be a huge relief to ailing India Inc. Also falling interest rate should boost investment which is much needed to bolster growth and does not pose immediate  inflationary pressure. Though it is made to look like a front loaded move and Governor seems to signal pause for the rest of the year, we expect further reduction of 50 to 75 bps later this year.  This sounds very optimistic, but isn't that the need of the hour?  

Hippity hip hurrah!

Wednesday, April 11, 2012

Spain, the next pain?

One more euro zone country makes headline.  Spanish bond yields surged (close to 6%) to a level which triggered some of the other European countries to seek bailout measures.  This is despite the austerity measure that the Spanish government announced recently.  Italian bonds also surged fueling concerns that euro zone's debt crisis is worsening. ECB recently had two tranches of liquidity infusion to ease tension.

Fourth largest economy of  euro zone Spain, is a part of PIIGS (Portugal, Italy, Ireland, Greece and Spain), countries worst affected by European debt crisis . As recently as January this year, S & P downgraded Spain's credit rating by two notches and set its outlook to "negative".  

Spain's public debt (as a % of GDP)  at 68.5% (2011) is lower than euro zone average of 90% and much lower than the other larger economies in the zone. Germany and France are above 80% and Greece close to 140%

GDP grew albeit at a slow rate of 0.7% last year as against Greece and Portugal's economies which registered -6.9% and -1.6%. However Spain's economy is expected to contract this year and continue to deteriorate as there are  deep spending cuts in its recent austere budget 

Deficit (as a % of GDP) is at a level comparable to Greece, Portugal and Ireland whereas unemployment at a whopping 23.6% looks worse than most of the other countries.  Spain is likely to miss its 2012 budget deficit goal approved by the EU. 

So, will Spain seek bailout?  A lot depends on its fiscal discipline.  Also tighter budgets (read reduced public spending) and high unemployment rate is not an exciting combination.  Significant part of bank loan has been extended to construction and real estate sectors which continues to be at a serious risk of default. This is only pushing up credit risk and borrowing costs further. While Spanish government is doing it's homework to put its house in order, Spain is likely to be dull and prolonged pain. 

Wednesday, April 4, 2012

Ws of Foreign Exchange Risk Management

When risk management motivations are forgotten, problems begin. Defining the objectives of a currency risk management program can be tremendously beneficial for all stakeholders. Articulation of these goals in form of a policy with ongoing education (on the importance of an agreed approach) ensures that  foreign exchange activities are aligned with primary business activities and organisation's risk tolerance. 

The more the time elapses between when an exposure is identified and when an offsetting hedge is placed, the greater the financial risk. Allowing subjectivity could mean more risk.  It is important that time lines are clearly defined on when exposures must be reported internally and when offsetting positions (hedges) must be entered into.  

Accountability is key. Functions and levels of responsibility should be clearly stated while developing risk management system. Many a times such responsibility starts and stops with financial decision makers such as CFO or treasurers.  However decisions that carry financial implications are made at other levels such as procurement  and sales teams. These are primary sources of uncertainty and the process should ensure accountability for communicating actual and expected foreign exchange exposure on a timely basis. Similarly treasury front and back office responsibilities should be defined categorically to ensure that all deals are reported, confirmed with counterparties to avoid financial implication due to process slippage.

Effectively managing market risk requires using hedging tools in a dynamic but disciplined manner. Risk management system / policy should not only define set of instruments that may be used by treasury but also describe criteria to be used to decide on their applicability under different market conditions.

Ensure compliance with extant regulations by regulatory authorities and internal guidelines and the policy should detail the same.  Performance should be measured against set objectives to ensure tweaking (if necessary) of existing approach. 

Ever increasing market volatility calls for a comprehensive risk management approach. Go for it! Well begun is half done!

Wishing you all a successful and profitable FY 2012 - 13!