1. Mid-Quarter Monetary Policy Review: September 2013
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The Reserve Bank of India cuts MSF by 75bps from 10.25% to 9.5%; reduces the minimum daily maintenance of the
cash reserve ratio from 99% of the requirement to 95% and to everyone’s surprise increases policy repo rate by
25bps from 7.25% to 7.50% in anticipation of rising inflation and anchoring inflation expectation.
Key Facts:
RBI in a surprising move raised policy repo rate by 25bps from 7.25% to 7.50%. Governor cited inflation risk still
persist due to supply side concerns and pass through of administered prices. Currency which added to inflationary
concerns have for now receded but cautious stance of governor deciphers that durable stability is still far away.
RBI believes inflation, which it expected to be at around 5% earlier, will be higher by the year end. However,
improved demand worldwide will recede inflationary pressures as the wedge between savings and investment
narrows.
Rajan has quite clearly dictated that RBI will adhere to its primary objective of monetary stability. Anchoring inflation
expectation is what RBI will need to work on. Note that Inflation expectation 3MF and 1YF was seen at 11.7% and
12.4% respectively in RBI’s 32nd
round of household survey.
Finally, new governor set himself to a neutral stance and articulated that decision in the coming policy or anytime in
near future will be only on the back of economic activity and updates.
Comments:
Bond markets were in a bull state earlier thinking of two parameters. First being benign inflation trajectory and
second being OMO expectation as to fund growth RBI will need to expand its reserve money. Now Participants see
inflation as a concern not only because it is rising but also for the fact that new governor will relatively weigh CPI
more compared to his predecessor. On the other hand Reserve money being a function of growth and interest rate
trajectory will seek less allocation as perceived earlier.
The spread between the Repo and MSF will be brought down to ~100bps from current 200bps in a calibrated
manner. Governor believes MSF (currently 9.50%) to do more of a walking for the same but didn’t deny that repo
can also support the spread to narrow.
As the lean season ends demand for credit is expected to rise looking at which India’s largest bank has increased
deposit subsequently lending rates. It will not be surprising if few more banks tweak their deposit and base rates
northward.
We believe RBI may bring down MSF gradually in a so called baby step manner. Expectation of falling overnight rates
will to some extent provide collateral support to the long end of the curve.
Banks are believed to be holding short term papers and bills heavily. As and when the carry, which is negative,
improves interest for long term bonds may regain albeit at a slower pace. Tight liquidity is seen as a deterrent for
spread assets. Adding to this supply of tax free bonds and NCDs are only compounding the pressure.
Investors for the near future will closely contemplate H2FY14 borrowing calendar to price domestic papers.
Thereafter markets are expected to be spearheaded by key US and domestic data points. Government’s action on
subsidy and spending, which seems quite narrow given state and centre polls are in transit, will support market and
sentiments.
