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June 2011

The RBI monetary Policy statement delivered a larger than expected 50 Bps hike in the Repo rate. Persistent elevated inflation and the lack of supply side responses  along with a largely accommodative fiscal policy have increasingly resulted in stronger monetary actions to restrain aggregate demand. Controlling inflation has emerged as the predominant concern for maintaining the medium term growth trajectory. The policy stance is dominated by the imperative to maintain an anti inflationary bias.

The policy actions are expected to maintain the credibility of the commitment of monetary policy to contain inflation. The policy actions largely follows the script of the annual policy review in May, where the stance of the policy had decisively shifted to controlling inflation and anchoring inflationary expectations. RBI has maintained its  baseline growth projection for the fiscal year at 8% and simultaneously increased the inflation estimate to 7%. RBI has also highlighted that the  overall buoyancy in consumption on account of increase in real wages could restrain significant growth moderation.

The larger than anticipated actions have resulted in market rates moving up by around 10bps across the curve especially in the 10y segment (8.42% 10 Y g sec and 9.47% 10y AAA). Since the  RBI has offered no guidance as to the anticipated peaking of policy rates, the near term market movements could remain volatile with a bearish bias. With the RBI having increased rates by 125 bps in the last 3 months, the additional policy actions are likely to be spaced out and in response to inflation developments. This could result in more of a volatile range for market yields.