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December 2012

RBI Monetary policy and bond market

The RBI, while keeping CRR and policy rates unchanged has signalled a shift in the monetary policy focus to manage "growth risks" going forward. The recent moderation in headline and core inflation reinforce the likelihood of a steady moderation in inflation readings in 2013-14. Anticipated moderation in inflation numbers would provide elbow room for a policy rate cut in the January review. The RBI has guided that liquidity conditions would be actively managed to support growth. With the CRR already at historic lows, incremental liquidity infusion measures would be largely through OMO’s. The possibility of rate action in the next quarter along with OMO’s to address liquidity tightness would ensure that bond yields remain soft.

The growth outlook has been maintained at the baseline projection of 5.8% with the recent reform initiatives likely to improve the investment climate. Excess capacity in certain sectors and the softening in international commodity prices are expected to lead to a softening bias in the core inflation numbers. The RBI has maintained the numerical estimates of growth and inflation and would review the same in the January review.

We have been maintaining high duration through exposure to government securities in our long term bond and gilt funds. We expect G-sec yields to soften further in anticipation of policy rate easing and continuance of OMOs by the central bank.

Moderation in inflation and interest rates augur well for equity markets. Global investors continue to pour money given the relative attractiveness of Indian markets while domestic investors have been net sellers. We expect equity markets to remain firm in view of economy and corporate profitability showing signs of bottoming out, Government's strong resolve to improve fiscal situation and revive the investment cycle and support from global liquidity. We also expect increased participation from domestic investors going forward.