Comments on RBI policy by Amar Ambani, Head of Research, India Infoline (a well diversified financial services company)

20th September, 2013 : Comments on RBI policy by Amar Ambani, Head of Research, India Infoline (a well diversified financial services company)

Also please find attached picture of Mr. Amar Ambani, Head of Research, India Infoline.

Raghuram Rajan, the new RBI Governor, in a surprise move, hiked Repo rate by 25 basis points with a view to anchor inflation expectations. Although the Nifty has fallen by over 100 points, in hindsight, it seems the right step by RBI, reaffirming its primary duty to keep inflation in check. For growth, the market should turn to the Government instead of the RBI.

 There has been an uptick in WPI over the past two readings on the back of sharp currency depreciation, ongoing de-regulation of fuel prices, and increase in international commodity prices. On the other hand, CPI which measures inflation at the retail level has been stubborn in the elevated range of 9-10% due to structurally high food inflation. The general inflation outlook is not very comforting despite high chances of robust kharif harvest and the negative output gap as suppressed inflation (impending large diesel price hike) is likely to play out.

 In line with expectations, the Central bank rolled back partially, some of the liquidity tightening measures taken in July to dampen speculation in the currency. The marginal standing facility (MSF) rate has been lowered by 75bps to 9.5% while the minimum daily maintenance of the cash reserve ratio (CRR) has been marginally reduced to 95%. Recent appreciation of the currency along with reduction in risks related to quantum and financing of Current Account Deficit (CAD) were the key drivers of this action. To ensure that markets don’t get carried away by this move, RBI has categorically mentioned that further change in the minimum daily maintenance of CRR is unlikely and further calibration of liquidity tightening is not given but would depend on currency stability. Also, the Central bank does not rule out re-tightening liquidity if external risks emerge.

 We believe that as a mature policy reaction, short-term rates are likely to marginally ease while medium-to-long term rates may move up. Therefore, the yield curve that was steeply inverted is expected to flatten a bit. We don’t expect many banks to hike their deposits and lending rates in response to the policy. It is challenging as well as detrimental to raise lending rates in fragile credit conditions. Monetary transmission has anyways been limited over the past couple of years. Banks are likely to show substantial MTM loss on their AFS investments in the current quarter as medium and long term bond yields are unlikely to come-off by the end of the month. Considering deepening growth slowdown, we do not envisage further repo rate hike in FY14. If the rupee continues to appreciate, then the MSF rate could be reduced further and that the overall liquidity window under LAF would be expanded.

 Central Bank Governors are in the mood to surprise markets these days. A day earlier, the Fed Governor did not even marginally roll-back its bond buying programme after much ado about withdrawal.