28th January, 2014
The December Mid quarter review had guided that future policy actions would be contingent on the direction of both headline and core inflation. Even though the headline inflation numbers had eased according to expectation, the core inflation numbers showed a moderate increase. Today’s 25 bps hike in repo rate may also have to be seen in the context of the Urjit Patel committee report which recommended a CPI inflation anchor for policy purposes and a CPI inflation target of 8% within a year. The rate hike reflects RBI’s assessment of the required policy stance to achieve the desired inflation trajectory. The policy guidance mentions that if the current disinflationary processes evolve according to the base line estimates , further policy actions may not be required in the near future.
The RBI guidance makes further rate actions data dependent. Overall a fair bit of uncertainty surrounds the medium term direction of CPI inflation considering the unaddressed supply side constraints. Though the lagged effect of tight monetary and fiscal policy, soft global commodity prices and high base effect in food prices should lead to softening of CPI next year. In the very near term, CPI inflation could trend downwards on account of easing in primary articles, which would most likely result in a phase of status quo on policy rates till the quarter end at least. Even though the formal adoption of the Urjit Patel Committee recommendations would depend on consultations with the government, we expect that incrementally monetary policy actions and operating procedure could evolve based on the broad guidelines of the report. This would entail that the RBI focuses more on headline CPI inflation, with active liquidity management through term repo auctions.
The governor mentioned that lowering of policy rates would not result in bringing down lending rates as savers have to be incentivized with positive real rates. Well anchored inflationary expectations is a necessary ingredient for sustainable growth.
The direction of long end gilt yields would be influenced by the evolving demand supply scenario, considering the challenging borrowing requirements expected over the coming years. In the interim, with the supply schedule for the current fiscal year drawing to a close, bond yields may trade in a range. The RBI is likely to be more proactive in addressing liquidity shortages which may recur over the coming months driven by government cash balances. We have been maintaining a lower duration in our funds considering the likelihood of a restrictive monetary policy outlook and also a challenging medium term demand supply equation for Gilts.