2QFY2014 Monetary Policy Review - Focus returns on growth-inflation dynamics

Pranam,

I wish all of you a Very Happy Diwali and a Prosperous New Year 

Policy Measures 

1. The Reserve Bank of India (RBI) delivered largely in line with our and the market expectations by hiking the repo rate by 25bp and reducing the Marginal Standing Facility (MSF) rate by a similar quantum. 
2. The repo rate now stands at 7.75% and the MSF at 8.25% with the corridor between the policy rates normalized at 100bp from 150bp earlier. 
3. The policy has continued to emphasize on price stability and anchoring inflationary expectations. The increase in repo rate is a follow up to a similar hike in the September policy review. 
4. The RBI has in fact eased liquidity conditions by also increasing the liquidity provided through term repos of 7-day and 14-day tenor to 0.5% from 0.25% of the banking systems’ NDTL. 
5. We believe that with stabilization in the exchange rate and unwinding of the exceptional short-term liquidity tightening measures, the focus has now shifted back to the growth-inflation dynamic being a determinant for further policy action. 

Respite on short-term borrowing costs 

With reduction in the MSF rate and increase in liquidity provided through the term repos to 0.5% of the banking systems’ NDTL, the RBI has reduced the marginal cost of short-term borrowings and effectively eased liquidity conditions for the banking system.

On account of this, we expect rates at the short-end of the yield curve to come down further by about 50bp. We believe that this would also lower the probability of broader lending rate hikes by banks for the time being. Over the medium term, the RBI has stressed on deposit mobilization as a ‘more durable strategy’ for liquidity management.

We believe that unless the gap between deposit and credit growth narrows, there is a possibility of banks hiking their deposit rates in the coming months to enhance deposit mobilization. 

Focus returns to growth – inflation dynamics 

With stabilization in the exchange rate and unwinding of the exceptional short-term liquidity tightening measures, the focus has now shifted back to the growth-inflation dynamic being a determinant for further policy action. 

On Growth: As expected, the RBI has revised its real GDP growth estimate for FY2014 downward to 5.0% from the earlier estimate of 5.5% in the July 2013 policy review. As against the 4.4% real GDP growth clocked by the economy in 1QFY2014, the RBI expects a modest pick-up in growth during 2HFY2014 owing to strengthening exports, anticipated growth in agriculture and signs of some revival in the services sector. We concur with the view that a meaningful revival in investment through clearances of large stalled projects by the Cabinet Committee on Investment is likely in FY2015.

On Inflation: In its assessment on inflation, the RBI notes that WPI inflation is unlikely to moderate substantially from current levels and expects CPI inflation to remain around or even above 9.0% in the months ahead notwithstanding the expected easing of food inflation. We continue to believe that food inflation is likely to moderate going ahead on arrival of new crop in the market as well as on moderate MSP hikes for food-grains, thus tempering headline inflation to that extent. The hawkish stance of the RBI can also be attributed to elevated inflationary expectations, anticipated pass-through from exchange rate depreciation 

and adjustment in administered fuel prices as well as sticky core CPI inflation above 8% levels. 

Future Outlook 

Going forward, we expect the course of further rate action by the RBI to be data-dependent and determined by the dynamics between growth and inflation. Clearly at this juncture, containing inflationary pressures remains its priority and through its stance it also seeks to anchor inflationary expectations and push up financial savings in the economy. 

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