Post monetary policy update

No surprises....concern over issues on growth; inflation and rupee remain valid

RBI delivered to expectations leaving CRR/SLR and policy rates unchanged. The guidance on the way forward was also to expectations. The end of the rate hike cycle was reiterated while highlighting the issues concerning significant downside risks to growth and strong headwinds on downtrend in headline inflation. RBI also stressed downside risks on rupee that would dilute its actions on inflation.

RBI also ensured post policy price stability by playing to the gallery. 10Y bond yield was steady around 8.45% taking bullish cues of RBI resorting to OMO operations to inject system liquidity on need based basis. Given the current liquidity squeeze of over 2% of NDTL; there will be steady flow of OMO purchases to limit weakness in 10Y bond yield above 8.5% despite pipe-line bond auctions and higher demand on slippage in fiscal deficit. The guidance on the way forward expressing concerns both on growth and inflation is negative for equity market. NIFTY will look heavy over 4850 and taking cues from the external sector, test/break of recent low of 4639 may be on cards for further extension into 4350-4250. RBI’s aggressive measures on the FX market will provide stability in rupee at 52-54. This level is seen as fairly valued for exporters and will not be considered as inflationary with good signs of downtrend in commodity prices.

What next? RBI is expected to stay in pause mode till March 2012. The external sector is still vulnerable with the belief that worst is still ahead. RBI will stay prepared for reversal of rate hike cycle by Q1 of FY13 post March 2012 inflation and growth numbers. The downtrend in growth momentum and headline inflation below 7% would trigger CRR and/or rate cuts. The risk to this expectation will be on headline inflation remaining stubbornly over 7.5-8.0%. While there is clarity on downtrend in growth momentum into 7.0-6.5% by 2013; concerns on inflation continue to stay valid with mix of supply side issues and high input cost of imports. Over all, the worst for money market is already behind while timing of easing cycle is uncertain at this stage. The system continues to be on “risk-off” mode to divert investment flows into fixed income from other asset classes.

There is hope of reaching the light at the end of the tunnel soon!

Moses Harding