Author: Aaron Chaze

CENTRAL BANK CHOOSES SLOWER GROWTH OVER HIGHER INFLATION

By Aaron Chaze

The Reserve Bank of India (RBI) has become the most proactive central bank in Asia for monetary tightening.

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Indian stock exchanges are performing poorly in 2011

With inflation hitting 9.4%, the Reserve Bank of India (RBI) has become the most proactive central bank in Asia for monetary tightening. It raised its repurchase rate 11 times since January 2010, the last was a 50 basis points rise on July 26—to 8%. The government is targeting inflation of between 5% and 6%—down from 9%. The RBI said recently it would prefer slower economic growth to higher inflation. India’s benchmark wholesale price inflation accelerated to 9.44% in June. The RBI maintains its GDP growth forecast of 8% for the fiscal year 2011–2012, a slight decrease from the 8.5% growth seen in 2011–2010.

Given the steady increase in borrowing costs and the expectation of another 50 basis point increase in interest rates before the end of the calendar year, the outlook has continued to weaken for Indian equities. Indian equity markets showed poor performance against other Asia Pacific countries during 2011—with the National Stock Exchange Nifty Index dropping 13% since January 2011.

In comparison, the Shanghai Composite has dropped by 4.4%, South Korea by 3.2%, and Hong Kong by 7%, while Indonesia has risen by 9.6%. Some Indian companies are likely to lower their earnings forecasts, which will add to the downward pressure on Indian equities.

To bolster capital-raising exercises, some large Indian companies have turned to overseas perpetual bonds—bonds with no fixed maturity. Ballarpur Industries—India’s largest paper manufacturer—is the latest, with a planned $300 million US dollar-denominated perpetual bond. Tata Power completed a $450 million perpetual bond issue earlier this year, while sister-company Tata Steel sold nearly 15 billion rupees worth of perpetual bonds. These bonds typically carry a higher interest rate than bonds with fixed maturities, and their equity features are attractive to companies looking to reduce debt-equity ratios or awaiting better conditions to tap the equity markets.