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May 2013

Views on RBI's Monetary Policy

The RBI policy review maintains the cautious approach towards addressing the slowdown in growth, in view of constraints presented by non monetary factors and weak external demand. The policy guidance maintains that on balance, the space for additional easing remains limited.  The baseline projection for GDP growth has been estimated at 5.7% and the average FY14 WPI inflation at 5.5%, with a focus on attaining March 14 inflation to a level of 5% using all possible instruments. The other notable change in the guidance pertains to the requirement of monetary policy to be vigilant towards the level and financing of the CAD which may warrant  a swift reversal of the policy stance. The HTM limit for banks investment in SLR has been aligned to 23% with a 50bps reduction to be made every quarter.

The RBI policy action remains consistent with the previous guidance where the RBI has stressed on supply side responses to revive growth and also the risk from CAD that may constrain aggressive rate actions. Recent macro data and developments related to the movement in commodity prices have reinforced the pattern of growth moderation and reduction in inflationary risks. The gradual correction in administered prices and resultant fiscal improvement, slowdown in both developed and emerging markets, lagged impact of tight monetary conditions and negative output gap reducing pricing power could lead to continuing moderation in inflationary expectations. CPI that has been sticky at double digit levels is also likely to soften from hereon. This should provide elbow room for policy rate actions in the coming months. Overall the guidance suggests the likelihood of incremental policy actions being largely data dependant and also being incremental in nature in the absence of any significant external shocks.

The absence of CRR cut suggests that OMOs would be the preferred response to addressing the liquidity deficits. This should ensure that bond yields stay supported with a gradual downward move over the year in response to rate actions and macro data.