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December 2011

RBI Monetary policy review
December 16, 2011

In the second quarter review of monetary policy in October, the RBI had mentioned that given the expected moderation in inflation, further rate hikes may not be warranted. In the mid-quarterly policy review release today, the RBI acknowledged the intensification of the downside risks to growth and hinted towards reversal of policy tightening cycle. The RBI has given the guidance that from this point onwards, monetary policy actions are likely to reverse the cycle responding to the risks to growth. Risks to growth have stemmed from lagged effect of policy tightening, turbulence in the global economy and financial markets and domestic policy uncertainties. While cautioning about the inflationary risks arising out of fiscal slippages and the persistence of inflation above the comfort zone, the RBI has mentioned that inflationary pressures are likely to abate given the deceleration in growth and softening in food inflation. On an overall assessment, the downside risks to growth have intensified given the moderation in investment activity. The RBI has also mentioned that further OMO’s would be undertaken as when considered appropriate given the persistence of deficit liquidity above the RBI comfort range. We believe that this measure could act as a near term support for market.

Though RBI abstained from giving a time frame on easing, we believe it could begin as early as the next quarter starting with a cut in the CRR. We expect them to continue with OMOs in the interim to ease liquidity which would act as a good support for the bond market. The pressure on the government fiscal situation would continue to be a source of market volatility. The prospects of liquidity supporting measures such as additional OMO’s and a CRR reduction eventually would prevent any sharp up move driven by any negative trends in the fiscal situation.

We have been bullish on interest rates since the last quarter and have been advising allocation in duration funds, considering the evolving macro situation. The change in the monetary stance evidenced by the second quarter review in October has been further reinforced by the dovish tone in today’s review. The portfolios of our short term and all duration funds have been positioned accordingly with a bias on high duration and with focus on higher rated credits. We expect that in the coming quarter, there is scope for  bond yields to soften further given the change in monetary stance.