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June 2012

Incoming macro economic growth data during the month surprised on the downside and has led to markets repricing expectations regarding the RBI monetary stance and actions. The Index of Industrial Production (IIP) data for the month of March 2012 declined by 3.5% on a y-o-y basis as against market expectation of +1.7% growth. Notwithstanding the volatility in the data series, the index reflected broad based deceleration across sub sectors and registered a growth of 2.8% for FY12 as against 8.2% in the previous fiscal year ending March 2011. The 4th quarter FY12 GDP (Jan-March 2012) grew at 5.3% as against consensus of 6.1%. The deceleration in the quarterly growth was driven by the manufacturing sector which declined by 0.3% y-o-y and signs of moderation in services sector growth.  GDP for FY12 grew at 6.5% as against 8.4% for FY11 primarily led by the slowdown in manufacturing. The GDP data releases have reinforced the slowdown in investment demand while pointing to moderation in consumption demand.

Headline WPI inflation came in marginally higher than expectation at 7.23% even as the core inflation reading remained below 5%. The recent significant moderation in international commodity prices, if sustained and the pronounced slowdown in growth numbers is likely to change the RBI policy rate guidance as given in the April review. The RBI resumed its OMO purchase program in the month as system liquidity deficit remained above the stated comfort zone and significant currency depreciation led to additional Forex interventions. The government bond yields reacted positively to the OMO program with the 10 yr benchmark yields moving down by about 30bps during the month. Inspite of the RBI refraining from continuing with the OMO since the last week of May, the weak GDP print has resulted in markets now discounting the possibility of additional rate cut as early as the June review. 

Incremental RBI actions are likely to proactively address the liquidity deficit in the banking system so that monetary transmission becomes more effective. Towards this objective we anticipate the likelihood of additional CRR reduction and other liquidity infusion measures on an ongoing basis.