Monetary Policy expectations:

Comfort on growth, suspect on inflation:

There is lot of hope, euophoria and optimism in step-up of GDP growth momentum. The set target of 5.5% for FY15, 6.25% for FY16 and over 7% by March 2017 is believed to be realistic not ruling out exceeding expectation. On the other hand, inflation-push factors stand diluted with sharp reversal in Brent Crude from over $115 to below $98 and long term Rupee stability at 60-63 with an acceptable 3% annualised depreciation to support exports and "make in India" campaign. The only (but major) concern is from supply-side worries on essential items which keep CPI at elevated rate without taking into account growth-push impact on inflation. RBI has set CPI target range of 6-8%, leaving 3 possibilities: (a) rate hike if over 8%; (b) rate-pause at 7-8% and (c) liquidity easing while at 6-7%. All taken, domestic cues have improved to dilute the conflicts in growth-inflation dynamics which caused RBI and FM to walk in different directions!

External cues not in favour:

FED is seen to start the rate-hike cycle by mid 2015 while ECB in extended ultra-dovish policy stance. This is minor relief but will cut RBI's band-width to turn ultra-dovish; significant squeeze in yield differential (at elevated CAD and inflation) will trigger accelerated Rupee weakness. There is need to manage interest rate and its impact on exchange rate to avoid emergence of growth-inflation conflicts. The comfort on availability of external liquidity is from emergence of India as the most favoured emerging market when opportunities are few in China, Russia and developed economies. All taken, while there are no downside risks, RBI might need to stay neutral (at best, mildly dovish) for extended period of time till shift of CPI target zone to 4-6% and sharp trend-down in twin-deficits.

Liquidity (and cost of liquidity) is the tool:

The intent of RBI is to retain operating policy rate at higher end of Repo-MSF corridor (currently at 8-9%) till comfort on inflation and twin-deficits with an agenda to keep Rupee exchange rate (above REER) attractive to exporters and FDI/FII inflows. At this stage (into busy season), liquidity is very comfortable with effective over-night rate at 8%, which is against RBI's scheme of agenda. There is downward pressure on shorter end of the rate/yield curve with flat 1-10 year curve around 8.5%. It is also fact that Banks hold huge excess SLR despite bringing the limit to 22% and retaining HTM at 24% defies logic! The excess SLR amounting to over Rs. 3-4 Trillion need to be pushed into the system for productive deployment. Bottom-line is that system liquidity is in plenty but credit-worthy opportunities are few! The immediate task for RBI is to push effective policy rate into upper-half of 8-9% through either suck-out of excess liquidity or through rate hike.

Policy expectations & impact:

1. Status-quo on policy rates with mild hawkish stone for either extended pause or movement either-way in alignment with CPI movement and directional bias. Impact is neutral to mildly bearish on equities & bonds and supportive to Rupee.

2. Status-quo on SLR with 50 bps cut in HTM from 24 to 23.5%. Impact is bond-negative, Rupee supportive and neutral on equities.

3. 50:50 probability between Status-quo in CRR and 50 bps hike from 4.0 to 4.5% with objective to push over-night rate into 8.5-9%. Impact is negative on Bonds, neutral on equities and supportive to Rupee.

4. Lots to be done on flow of liquidity to infrastructure, manufacturing and agriculture to support Government's initiative to step-up all-round growth momentum. More to hear on development of vibrant bond market as alternate financing channel and to reduce pressure on commercial banks. Huge monies on tap with domestic Insurance, Provident & Pension Funds, ultra-high net worth individuals & Family Offices/Trusts and off-shore institutional investors. Financial Inclusion is another agenda where entities are ready to extend spoke support (for reach-out to bottom of the pyramid) from the last-mile hub branches of financial entities. Impact on markets will be positive as these measures will improve productivity and efficiency for uplift of economic and social well-being!

As the "talk" is getting louder with attention in plenty, RBI support to walk-the-talk will be keenly watched on how financial services will be geared to meet expectations. There is huge expectation from the RBI Governor with confidence that Dr.Rajan will do the best managing (and balancing) the expectations of stake-holders. Good luck, Raghu Rajan!

Moses Harding