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January 2013

CIO's View on RBI Monitory Policy - 29th January 2013

Softening in headline inflation, significant moderation in economic growth and recent policy initiatives from the government have led RBI to cut policy rates and CRR by 25 bps each. We think that policy tone has clearly turned more dovish and has recognized the downside risks to the growth as inflationary pressures seem to have peaked for the time being. 

The CCR reduction would infuse primary liquidity to the extent of Rs180bn and is intended to ensure that liquidity conditions going forward do  not constrain credit flows. CRR cut would  ease the near term liquidity pressure but we believe that it will have to be followed by Open market operations to bring liquidity deficit in line with RBI’s comfort zone. The widening gap between the deposit and credit growth rates can constrain the systemic liquidity going forward and would require additional liquidity enhancing measures. 

The government commitment on maintaining the revised Fiscal deficit target of 5.3% for FY13 has been acknowledged by the RBI, removing the likelihood of additional borrowings in the current fiscal year. 

The governor has explicitly highlighted the need for increased government action to revive investments and ease the supply pressures which are critical for sustainable non-inflationary growth and macro-economic stability. While articulating what needs to be done by the government, he has expressed limited role that monetary policy can play in reviving the growth momentum in the current scenario. RBI also needs to be cognizant of the risks arising from twin deficit amidst an uncertain global environment. The fiscal framework and stance of the FY14 union budget could set the tone for further RBI policy actions. 

We expect another 25 bps rate cut in March followed by additional easing in the next quarter contingent on the fiscal consolidation and supply side initiatives. 

We retain our positive bias for the bond market from a medium term perspective. Given the expectations of further policy rate cut and likelihood of fiscal deficit for FY 2013-14 coming in at around 4.8%, we expect bond yields to ease further. We have been maintaining high duration in our long term gilt and bond funds through exposure to government bonds. 

Equity markets are likely to maintain the positive momentum and all eyes would now be on the Union budget. Given the trend in policy initiatives and comments from the finance minister over the last few months, we are optimistic that Budget would set the tone for fiscal consolidation and continuance of policy reforms.