RBI Monetary policy review
January 24, 2012
The RBI in the third quarter review of monetary policy has shifted the growth-inflation balance of the monetary policy stance to growth, while at the same time ensuring that inflationary pressures remain contained. In continuation with the definite shift in the monetary stance in the December review, the RBI has cut the CRR to address the structural liquidity shortage in the system and to provide primary liquidity on a more enduring basis. The cut in the CRR is meant to ensure that the current tightness in liquidity does not impair the flow of credit to productive sectors in an environment where the downside risks to growth have magnified. The immediate impact of the CRR cut would be an increase in the primary liquidity to the extent of Rs 32000cr. This should moderate the extent of the current tightness in systemic liquidity. The RBI has reduced the fiscal year end GDP estimate to 7% and maintained the estimate of 7% on the year end the inflation reading .
The policy review states that based on the current inflation trajectory, including consideration of suppressed inflation, it is premature to begin reducing the policy rate. The RBI has cautioned that in the absence of structural measures to improve the supply side response and fiscal consolidation, the Reserve Bank will be constrained from lowering the policy rate in response to decelerating private consumption and investment spending. This puts the onus on the government to deliver on the fiscal side starting with the forthcoming Union budget. in the near term the trajectory of bond yields would be dependent on the continuation of the OMO program.
Bond yields have been softening on expectations of reversal in rate cycle and continued Gsec buying by RBI through Open market operations. We continue to maintain a positive bias on interest rates over the medium term and have strongly been recommending dynamic bond fund for investors with risk appetite and long term investment horizon. We also recommend short term fund with horizon of at least 6 months as money market and short term yield curves are attractively priced. Given the macro environment, our bias would be towards maintaining higher duration and keeping a very cautious stance on credit risk across fixed income portfolios.