RBI's monetary policy stance on 19th March 2013

RBI is seen obliged for shift into dovish monetary policy stance

There is unanimous expectation of 25 bps cut in policy rates and CRR on 19^th March mid-quarter review of monetary policy, but what is more relevant is RBI’s policy tone (and guidance) for shift of its priority (and support) to growth with good comfort on moderation in inflation. The disappointment on 29^th January is still in memory; despite delivery of cuts in policy rates and CRR, hawkish guidance on the way forward set the bearish tone on markets for post-policy collapse of 10Y Bond from 7.78% to 7.93%, NIFTY down from 6110 to 5850/5650 and Rupee down from below 53 to above 55. However, post-Budget FY14 optimism (and confidence on the way forward) has provided stability to markets, and the attention now is on RBI for directional guidance. There are good reasons for RBI to shift its concerns from inflation to growth, and to set the monetary conditions as catalyst to growth and fiscal consolidation.

·       The Government has delivered on fiscal consolidation and policy reforms. The commitment to contain fiscal deficit at 5.2% for FY13 and high confidence to achieve 4.8% for FY14 means that the Government has tightened the screws on the loose fiscal policy. The Government is on over-drive to remove policy-irritants and roll-out new reforms to attract foreign and private investments for revival of core sectors and capacity expansion of the economy. Global rating agencies have responded positively on Government’s efforts to address their main concerns on policy paralysis and fiscal consolidation, but remain suspect on growth aspiration. The risk of sovereign rating downgrade is no more a risk factor, but restoration of stable outlook (and rating upgrade) is dependent on achieving FY14 GDP growth target of 6.5% and prepare for step-up into 7.0-8.0% in FY15.

·        The Government is doing its best to address issues related to the Current Account Deficit. The measures to cut consumption of essential imports (through removal of subsidies) and discourage import of non-essential consumption are steps in the right direction. In the interim, efforts are on to attract FDI/FII flows to fund the current account deficit to dilute its impact on the rupee exchange rate. The impact is already visible with expectation of monthly CAD at $10-15 Billion which can be easily bridged through capital account flows and “lead” of dollar supplies from exporters. CAD and weak rupee are now not seen as risk to inflation.

·       The Government’s delivery on fiscal deficit (and consolidation) is highly dependent on stepping up the GDP growth momentum from below 5% (FY13) to above 6.5% in FY14. This will be difficult to achieve without strong tailwinds from favourable monetary conditions of low interest rates and surplus system liquidity. The UPA regime has the agenda to achieve higher growth trajectory (at moderate inflation) before 2014 general election.  

At this stage, twin-deficits (and Rupee exchange rate) are not seen as major risks on inflation. RBI should ensure that monetary conditions do not remain as risk to growth, and to align the monetary policy to reflect tight fiscal policy. It is not in the interest of the economy if tight fiscal policy and tight monetary policy co-exist.  

• The only irritant for RBI is from elevated CPI inflation and double-digit inflation of food, fuel and essential items linked to basic consumption. While nothing much could be done to address this through monetary policy, Government is seen to guide soft-landing through squeezing the demand-supply gap.
• RBI should derive comfort from sharp decline in core inflation to below 4%; huge gap between core inflation and headline print create good space for monetary easing even at the cost of marginal uptrend in core inflation.
• Tight system liquidity and lag in deposit growth will dilute monetary easing impact on the deposit/lending rates. It means that even an aggressive reduction of 75 bps in the operating policy rate, impact on savings/investments may not be significant, thus giving a good balance to growth, savings, investment, consumption and inflation dynamics.

Given these dynamics in play at this stage, there is strong case for RBI to cut the operating policy rate from current 7.75% to 7.0% and CRR from 4.0% to 3.0%. If the need to turn the monetary conditions to pro-growth is valid, it would be prudent to front-load the action rather than taking baby-steps! MARKET PULSE sees merit (and prudence) in RBI delivering 50 bps cut in policy rates and CRR to drive the 3-12M deposit rate at 8.0-9.0%, and to maintain drawdown from LAF counter at reporting fortnight average of Rs.50K Crores. While stability in money market rates will provide balance to the interests of investors and borrowers, rally in asset markets will add to confidence of stake holders. The resultant accelerated foreign currency inflows and supply-driven mode in the forward market would get RBI into the act of arresting rupee appreciation, thus easing the pressure on domestic system liquidity through aggressive dollar purchases. The remedy to expand system liquidity is either through expansion of RBI’s balance sheet or dollarization of its assets. The cost-benefit (and risk-reward) to the Indian economy is clearly in favour of RBI’s giant steps towards the set objectives of operating policy rate at 7% and CRR at 3%. It is a win-win proposition for all stake holders, and the UPA coalition ahead of 2014 elections!

The post-policy range is seen for NIFTY at 5600-6100, 10Y Bond at 7.75-7.95 and Rupee at 53-55 and markets are indecisive, trading at the middle of these ranges with attention on RBI. MAREKT PULSE remains bullish on markets taking comfort from RBI’s obligation to walk along with the Government. It happens everywhere, why not in India when risks to inflation from twin-deficits is significantly diluted?

Moses Harding