RBI's monetary policy announcement and its implication on investment strategy . . .

1. Monetary Policy
Review
18 Dec 13

2. Announcements
• Contrary to consensus view, the RBI left the Repo Rate unchanged
at 7.75% in the mid-term review of the monetary policy.
- Terming its decision to hold rates as a ‘close one,’ RBI cited uncertainty surrounding the
short-term path of inflation and weak state of the economy as the key determinants.
• The MSF rate was also retained at 8.75% and thus the corridor at
100 bps.
• CRR was also left unchanged at 4%.
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3. Implications – 1/2
RBI adopts wait and watch approach
One of the main motive for no rate action is downward inflationary
outlook especially food inflation which is likely to sharply ease down
from the current spike. Any further hike from hereon would have
increased the borrowing costs and thereby impacting the Government,
so we believe RBI has maintained the key rates and is waiting for
more evidence on inflation before taking any action.
Willing to raise rate out-of-turn, if inflation climbs further
While RBI expects inflation to moderate from here on, it also remains
willing to raise rates if the recent inflationary pressures (pre-
dominantly driven by food and fuel groups) become more generalized
and starts getting reflected in core CPI/WPI data. Is he waiting for just
confirmation (in terms of higher core CPI) before hiking interest rate?
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4. Implications – 2/2
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System liquidity has eased considerably; short term rates to
remain benign
Liquidity conditions have improved significantly since the normalization
of exceptional monetary measures. Capital inflows under the central
bank’s swap facilities for banking capital and non-resident deposits
augmented domestic liquidity substantially. Consequently, commercial
bank’s borrowings under MSF have declined steeply and there has
been a sharp reduction in money market rates. In the first two weeks
of December, liquidity in domestic system was fairly
balanced. As RBI intends to ensure that liquidity is available for
growth, short term rates are likely to remain benign for the rest of the
fiscal.
One more rate hike can not be ruled out, but policy easing some
time away
While there remains a probability of 25 bps repo rate hike in near term,
RBI has maintained their position on nimble footing. We think that
monetary easing is still some time away, as that would demand
sustained and significant moderation in inflation.

5. Suggestions
• Looking ahead, market has largely discounted the lack of OMOs
and the same is getting reflected in prices. As for the bond-switch,
while the uncertainty is likely to sustain, we believe that it will be
done in a non-disruptive manner and largely with institutions that
can absorb the longer duration bonds (presumably EPFO, LIC etc.).
However, till this uncertainty remains the market may be somewhat
suspicious of the mid to long end of the curve. Shorter end of yield
curve may soften with better liquidity. However, as in next monetary
policy, there is a possibility of hike in repo rate (depending on levels
of inflation), the shorter end of yield curve may start facing volatility.
• Under such circumstances, tactically –
 for risk-averse investors it makes sense to remain closer to Ultra ST
Funds and short tenured FMPs (preferable monthly interval plans).
 for investors who are willing to have relatively longer investment
horizon (more than 18 months) and who are ready to see interim
volatility, can invest some portion (say, 15-20%) of portfolio in
Dynamic Bond Funds / Income Funds.
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Jignesh Shah
Capital Advisors
+ 91 – 9820296989
jshah@capitaladvisors.co.in
Contact Details

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