December 18, 2013
The Reserve Bank of India kept policy rates unchanged at a time when consensus was signalling a 25bps repo hike. RBI’s status quo decision is predominantly driven by weak macroeconomic situation and steady core inflation with anticipation of softening in food prices particularly fruits and vegetable prices. While recognising that the policy decision was a “close one”, RBI has explicitly given high importance to the next inflation reading indicating it would react even on non policy dates in case the expected softening of food inflation does not translate in reduction in headline inflation.
The policy statement and action seem dovish and signals limited impact of monetary actions on inflation which is predominantly on account of government policies and supply side issues. Market has reacted positively to the ‘wait and watch’ policy action of RBI with the benchmark 10 year rallying more than 10 bps post policy.
However, there still exists a strong case for inflationary pressures to persist and a consequent rate hike to stabilise inflationary expectations. Moreover, with significant reduction in tax collection targets and disinvestment projections, fiscal deficit management will be a challenge and is likely to be achieved by curtailment/ postponement of government spending.
Though improvement in trade deficit data and build up in foreign exchange reserves on account of the swap window has provided significant cushion in case of tapering by US Federal reserve tapering, actual impact can only be gauged as and when the event unfolds.
We continue to maintain a cautious stand as inflationary expectations remain elevated and RBI may have to act in the coming quarter. In the coming month, heavy supply schedule and the possible bond switch program may keep long bond yields elevated. Normalisation of operational rate and easier liquidity will keep short end rates well anchored.