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May 2011

RBI Policy & Markets

RBI has continued with its anti inflationary monetary policy stance and raised repo rate by 25 bps to 7.50% today. This is the 10th rate hike since last year. WPI for May at 9.06% came in higher than market expectations and more worrisome was core inflation that was at 7.3%. RBI has mentioned that inflation continues to remain its primary concern while there is no evidence of a broad-based deceleration in economic growth.  It believes that underlying inflationary pressures are not fully captured in the headline number. In fact, the pass-through of higher global energy prices is yet to be factored in.

We expect growth momentum to decelerate further in view of global uncertainties, lagged impact of monetary tightening and policy standstill. While the near term pressures are evident, inflation could moderate in medium term given that global commodity prices are showing signs of cooling off and monsoon seems to be normal this year. Bond yields are unlikely to soften much from current levels in the immediate term in view of hawkish stance of RBI and continued supply pressure. However, we believe that RBI is near the end of tightening cycle in terms of policy rates and global environment is turning positive for bonds. Though market may remain in a trading zone for some more time, we believe that investors with risk appetite and longer horizon should consider investing in Dynamic bond fund.

As far as liquidity situation is concerned, the worst seems to be behind us as structural mismatch in credit-deposit ratio is getting corrected. Investors should take advantage of high short term yields by investing in accrual products like short term funds and FMPs. 

Equity markets have been showing resilience despite the global uncertainties, policy gridlock, inflation and rising rates and slowdown in earnings momentum. Valuations are in line with long term averages and capture the negative news to a large extent. Markets may show higher volatility in line with the global markets, however, investors should take advantage by increasing allocation to equity markets as long term outlook remains positive despite the near term headwinds.