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June 2012

CIO's view on RBI Monetary Policy
June 18, 2012

The RBI moved against market consensus and opted to keep policy rates and the CRR unchanged given elevated headline inflation, uptrend in retail inflation indices and the lack of supply side responses. The additional leeway on Export credit refinance to the extent of 50% of eligible export credit, provides additional refinancing to the extent of Rs 300 bn. The impact of the same may be limited on a system wide basis given the excess SLR, but could broadly be comforting on the liquidity front. The possibility of further quantitative easing in the developed world which could reverse the slide in oil prices and the sharp rupee depreciation which could act as  a demand stimulus could have weighed in on the RBI policy stance.  They would also like to wait and watch for trends in Monsoon and its impact on food prices. The RBI has reinforced the stance of policy moves to be dependent on the evolving growth – inflation dynamics. In contrast to the previous policy in April, where the policy rates had been cut in response to growth falling significantly below the post crisis trend, the decision  on future rate moves would be dependent on the assessment of inflation risks.

The policy statement has unambiguously made the case for revival of investment sentiments to be led by fiscal consolidation and other supply side initiatives apart from demand moderation measures through appropriate pricing of administered products, while monetary policy acts to anchor inflationary expectations. In the absence of major external shocks impacting financial stability, the incremental RBI actions would be more circumspect and data  driven. However, we expect liquidity infusion measures through additional OMO’s or CRR action going forward.

By not succumbing to pressure on rate cuts, RBI has signaled that it is the fiscal response on policy and execution that is critical to augment supply side and revive growth. Over-consumption by government and lack of supply side measures are one of the key reasons behind stickiness in inflation and slower growth. RBI can’t alone be burdened for dealing with inflation as well as  growth.

Bond yields have moved up post the policy announcement. We had lightened duration in fixed income funds ahead of the policy but will look to add Gsecs at lower levels. We think RBI would continue with OMOs and that would check the upside in yields.

Equity markets have corrected today led by fall in financials. The event risk of Greece election results and RBI policy are behind us. While further monetary easing by ECB is a given, markets would watch out for outcome of US Federal Reserve Open market committee (FOMC) meeting this week. We expect incremental government action post Presidential election as the finance ministry undergoes a leadership change. Though monsoon is another factor that could impact sentiments, we continue to believe that investors should build exposure to equities with a long term perspective.