RBI's stance on 3rd May?

Tough for RBI to shift priority from inflation to growth

It is one of rare occasions when market stake holders are unanimous in demanding 25 bps rate cut from RBI. There are strong reasons for it; (a) headline WPI inflation is below 6% (b) core inflation is steady below 4% (c) inflationary build-up from twin-deficits are diluted (d) real interest rates not considered as major threat to savings, investments and flight of capital to non-financial assets and most importantly (e) need to step-up growth momentum from below 5% to above 6% to support fiscal consolidation. There has been a structural shift; fiscal consolidation is not seen as threat on inflation but growth pressures are emerging as threat for fiscal consolidation. All taken, there is need for RBI to shift its priority from inflation-control to growth-support and stay dovish on its monetary guidance. RBI’s concerns are from lack of policy reforms to spur growth and heightened political risk limiting the UPA Government in roll-out of reform process. The sustainability of current set-up of bullish cues is in doubt. There is no clarity from external cues as well; BRENT Crude and Gold has unwound most of its recent losses while turnaround signals in global economic recovery are not yet in sight. It may not be prudent for RBI to shift into loose monetary policy stance given these uncertainties. So, what to expect from RBI and its impact on markets?

RBI will deliver 25 bps rate cut and provide signals for some more limited space which should push the LAF corridor from  current 6.50-7.50% to 6.0-7.0% by end June 2013. So, it is a choice between front-loading of 50 bps rate cut now or phase it out in two stages; one on 3^rd May and next in June mid-quarter review. RBI may prefer to deliver in 2 lots sticking to its baby-step approach. The liquidity condition of the market is comfortable at around deficit of Rs.1 Trillion. The draw-down from LAF counter is mostly to refinance excess SLR book rather than to treat the same as overnight OMO bond purchases for credit expansion. While there is demand for CRR cut from most Banks (for bottom-line benefit), RBI’s preference is for SLR cut. The ideal situation with least impact on price stability will be for gradual move of CRR from current 4% to 3% and SLR from current 23% to 22% (total statutory holding down to 25% of NDTL). It may not be a surprise if RBI delivers cut in CRR or SLR or both aggregating to 50-100 bps to retain LAF drawdown within its comfort zone of 1% of NDTL deficit or surplus. These monetary actions will provide clear signals of RBI’s growth supportive stance and its comfort on soft-landing of inflation in the short term. It is important for RBI to stay neutral (to dovish) on its guidance; there may not be space for more rate cuts but option to shift system liquidity from deficit to surplus mode has room for fall in over-night rates by 1%. All told, monetary policy will stay supportive to growth (and asset markets) into the short/medium term.

The impact on asset markets will be neutral to mildly positive. There are no reasons to turn bearish given the dilution in conflict of play between growth-inflation dynamics. NIFTY should regain its pre 29^th January monetary policy high of 6111 for shift into short term trading range of 5800-6300. Rupee will stay bullish for recovery into post 29^th January monetary policy high of 52.88. It would position RBI to cover its earlier forward sale of dollars (at over $10 Billion), re-build its dollar reserves to earlier high of around USD 350 Billion and to maintain exchange rate competitive (and attractive) for exporters till economic recovery in western economies. RBI would be seen absorbing excess dollar supplies at/below 53.60-54.10. 10Y Bond has rallied sharply since September 2012 from 8.25% to 7.75%. While the medium/long term outlook is bullish subject to deliverables on various factors, near/short term outlook is neutral driven by demand-supply mismatch. The investor appetite for 10Y Bond at 7.60-7.75% may not be good when pipe-line fresh supplies are huge. The cut in HTM limit and resultant unwinding of long bonds will limit extended bull-rally in the Bond market. It is also in order for stability in 10Y Bond yield at 7.65-7.90% when overnight operating policy rate is expected to stay steady at 7% in the near/short term, thus building adequate tenor premium. The post-policy trading range is seen for NIFTY at 5800-6300; Rupee at 53.60-54.60 and 10Y Bond at 7.65-7.90. There are no strong cues for break-out either-way given the strong cross-winds in play; it would be period of consolidation in the short term while awaiting cues for directional guidance into medium and long term.

Moses Harding