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October 2011

RBI Monetary Policy review
October 25, 2011

The RBI has raised policy rates by 25 bps in its Monetary Policy Review today. The RBI’s decision to continue to hike rates  is based on the fact that both inflation and inflation expectations remain high. Inflation is broad-based, and is above the comfort level of the Reserve Bank. The RBI expects high inflation levels to persists for the next couple of months but has acknowledged that the deseaonalised quarter on quarter headline and core inflation measures, indicate moderation and expects headline inflation to fall to 7% by March 2012. The RBI has also acknowledged that growth is clearly moderating on account of the cumulative impact of past monetary policy actions. The RBI would drive comfort from the expected outcome of moderating inflation which would provide some room for monetary policy to address growth risks in the short run and thus has indicated that the likelihood of a rate action in December mid-quarter review is relatively low.

The RBI reiterates that there are several factors -  structural imbalances in agriculture, infrastructure capacity bottlenecks, distorted administered prices of several key commodities and the pace of fiscal consolidation – that combine to keep medium term inflation risks in the economy high thus as always, actions would depend on the evolving macroeconomic conditions.

Bond yields reacted positively post the announcement with the 10 year government bond falling by 10 bps to 8.67%. We expect the RBI to pause going ahead on account of moderation of domestic growth and ongoing global concerns. Down side in bond yields could be limited considering the large supply and fear of further slippages in the fiscal deficit but any indication of OMO by the RBI would provide further comfort.

RBI has decided to deregulate the savings bank deposit rate. Banks should offer a uniform interest rate on savings deposits up to Rs.1,00,000, irrespective of the amount and are free to offer differential rates over Rs.1,00,000.

Given that we are almost close to peak of policy rates and bond yields, we advice investors to invest in duration funds. Our Dynamic Bond fund is positioned to capitalize on opportunities across all segments of fixed income markets.

Expected pause in monetary tightening is positive for equity markets, however, near term direction would depend on news flow from European markets.