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RBI's monetary policy review

October 29, 2013

The RBI continued the process of normalizing the conduct of monetary policy with a 25bps reduction in the MSF while simultaneously hiking the repo rate by 25bps to 7.75%. The RBI also announced additional access under term repo for a cumulative availability of funds to the extent of 0.5% NDTL. With the additional access under term repo which amounts to Rs 40,000 crores, over and above the 1% of NDTL access under overnight repo and Export credit refinance, the recourse to funding under MSF may gradually reduce. This should allow short term rates to gradually ease in the absence of significant additional currency withdrawals from the banking system in the coming months. With the RBI stressing on enhanced efforts to mobilize deposits as a durable strategy for mitigating mismatch of funds, it can be expected that the central bank is unlikely to revert to unlimited overnight funding under LAF in the near term. The RBI estimate for FY14 GDP growth has been revised to 5%, with the CPI inflation estimated to remain above 9% in the coming months in the absence of policy action. 

The policy stance continues to be guided by the consideration of anchoring inflation expectations and curbing inflationary pressures as a prerequisite to maintaining macroeconomic and financial stability. The hike in the repo rate must be seen in the context of continued focus from recent RBI statements on increasing financial savings, which would strengthen the foundations for growth. Towards this objective, issuances of CPI linked savings securities for retail investors would commence from Nov/Dec 2013. The policy stance continues to be neutral with the evolution of inflation trajectory likely to influence additional moves on the repo rate. A gradual resetting of the effective overnight rate closer to the repo rate could result in easing of long bond yields from current levels. Additional policy actions based on RBI’s assessment of consumer inflation and the evolution of the fiscal deficit trajectory in an environment where the RBI may be circumspect with OMOs would limit any significant directional easing in long term yields. The front end of the curve looks better as at some point the operational overnight rate will move back close to the repo rate. 

We expect Gsec yields to remain range-bound with periodic bouts of volatility driven by incremental supply-demand dynamics. While the hawkish stance will limit the downside, positives could come in the form of possibility of inclusion of Indian Gsec in global bond indices, softening of food prices leading to moderation in CPI and operational overnight rate shifting back to the repo rate. Yield curve is likely to steepen further driven by fall in yields at the short end.