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July 2012

The RBI policy review was on expected lines with key policy rates being kept on hold. The RBI however delivered a surprise SLR reduction. The growth estimates for the year have been revised downwards from 7.30% to 6.5% while the year end WPI inflation is now estimated at 7.00% as against 6.5%. The policy challenges in the coming months have been clearly manifested in the estimates with the moderation in headline and core inflation not commensurate with the slowdown in growth. Uncertain global environment with potential negative spillover effects, deficient monsoon pushing up food inflation and the twin deficits on the current and fiscal account have been identified as key risks factors in the evolution of growth and inflation dynamics.

The persistence of inflation at higher levels in spite of growth slowdown, a lower output gap and the requirement of providing adequate liquidity have shaped the current policy stance. The reduction in SLR should be seen in the  context of ongoing RBI efforts to ensure adequate liquidity for funding credit needs. This has put near term pressure on Gsec yields, but in the current environment with banks holding excess SLR, the impact of the same would be diluted. The SLR cut could also put more pressure on the government to respond on the fiscal side, in our view. The policy guidance conditions further monetary easing on adequate steps by the government to address the supply side constraints. In this context, the RBI is likely to proactively respond to growth moderation.

In the absence of adequate fiscal measures, the incremental RBI actions would be focused on ensuring adequate liquidity within the stated comfort zone and also to ensure that external shocks, if any, do not adversely impact domestic growth and financial stability.

The G-sec market has reacted negatively on SLR cut. We had lightened duration across our funds ahead of the policy in anticipation of a status quo on policy rates. However, given the medium term positive outlook, we would look to increase duration on uptick in yields. There will be lot of supply in August providing good entry and trading opportunities. We remain positive on the short to medium term AAA rated bonds which form the core portfolio of our short term and long term funds.