RBI's Mid-Term Monetary Policy Review – highlights
The Reserve Bank of India (RBI) kept its policy Repo rate and Cash Reserve Ratio (CRR) unchanged at 8% and 4.75% respectively against the market consensus of 25 basis points (bps) cut in the repo rate. It may be noted that, the series of weak macroeconomic data in the recent past, such as lowest quarterly GDP growth of 5.3% in the 4th Quarter of FY2012 and the continuing weak trend in Index of Industrial Production (IIP) growth had resulted in the market expectation that RBI would cut the policy rates at least by 25 bps.
To augment liquidity and encourage banks to increase credit flow to export sector, RBI has increased the limit of export credit finance from the present 15% to 50% of the outstanding export credit. This will release additional liquidity of over Rs. 300 Bn, equivalent of 50 bps reduction in the CRR. In its policy statement, RBI stated that interest rates have had only a limited role in the current growth slowdown and depend much on reform process. It also noted that, the head line inflation remains above the levels consistent with sustainable growth. While cutting the rates by 50 bps in its April policy, RBI had stated that further rate cuts would depend on path of fiscal consolidation, the movement in global commodity prices, especially international crude prices and trend in inflation. While there has been no action on fiscal consolidation front, the international crude prices have come down significantly since then. However, the depreciation in rupee has significantly offset its impact. The headline inflation which moderated from the peak of 10% in 2010-11 to 7.23% in April has moved up to 7.55% in May, though the core inflation at 4.85% is still showing moderating trend. RBI has further noted that the Consumer Price Index (CPI) inflation currently at 10.4% is showing consistent upward trend, indicating serious supply bottlenecks and sticky inflation expectation. These factors have probably constrained the RBI in easing policy rates despite the steep deceleration of economic activity. RBI has stated that the evolving growth-inflation dynamics will influence its stance on interest rates and it will continue to use OMOs as and when warranted to keep the liquidity in a comfortable zone. The Bond Markets quite expectedly reacted negatively to RBI's move. The 10 year benchmark yield moved up by 10 bps after the policy announcement and the same is presently trading around 8.13%. We expect that, despite the present pause and rather mildly hawkish stance of RBI, given the weak growth scenario, RBI would ease policy rates in the coming months. This expectation and the RBI's commitment to manage liquidity through OMOs will cap the yields from moving higher. We expect the 10 year benchmark yield to trade in a broad range of 8- 8.25% going ahead.
Best Regards
Prakash Nair
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