The Reserve Bank of India raised interest rates by 25 basis points to 8% and 9% for the repo and MSF rates respectively, citing elevated consumer price inflation levels. The rate hike is aligned with recommendations to reduce inflation to below 8% by January 2015 and 6% by January 2016. Future policy actions will depend on the inflation trajectory - if inflation moderates as projected, further hikes may not be needed. While inflation is expected to fall, economic growth in the current fiscal year is projected to be lower than earlier estimates of 5%.

1. Monetary Policy
Review
28 Jan 14

2. Announcements
• While leaving the repo rate unchanged in Dec’18 policy, when the
consensus was expecting a hike, this time RBI surprised negatively
with a rate hike when the consensus was of a status quo.
• The repo and MSF rates were raised by 25bps to 8% and 9%
respectively
• The CRR was left unchanged at 4%.
• The decision to hike policy rate was solely driven by elevated level
of core CPI in recent months notwithstanding steep growth
slowdown and 50bps rate hike between Sept-Dec 2013.
Other take-aways:
• CPI Inflation to remain above 9% in rest of FY14 but fall to 7.5% -
8.5% by Q4 FY15.
• GDP growth for FY 14 could be lower than RBI's earlier estimate of
5%. But in FY 15, GDP growth is likely to fall in the 5% - 6% range
(balanced around central est of 5.5%)
• Current Account deficit expected to be below 2.5% of GDP for FY
14 (vs 4.8% in Fy 13)
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3. Implications
Dr Urjit Patel Committee Report
The rate hike is in-line with the path for dis-inflation recommended by
the expert committee on monetary policy framework which suggests
CPI inflation target of below 8% by January 2015 and below 6% by
January 2016.
Future policy action hinged on CPI trajectory
RBI clearly mentioned that future policy actions would be determined
by the pace of moderation in CPI inflation. If the disinflationary
process evolves according to central bank’s projection, then further
rate hikes may not be warranted. We believe that such critical level of
CPI would be 8%, below which a change in policy stance is unlikely.
Policy rate may have peaked but a long pause will follow
As inflation is expected to recede in coming months on the back of
persistent correction in food prices, we think chances of an
incremental rate hike is negligible and that the rate cycle has peaked.
Therefore, one can expect a fairly long phase of ‘monetary pause’. In
the recent past, transmission of policy rate hikes has been very limited
due to modest credit demand and improved traction in deposits
growth. So, banks are unlikely to respond to this rate hike.
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4. Suggestions
• Looking ahead, the growth prospects for FY15 would be
constrained by interest rates remaining sticky at the current level.
Further, with Elections in May 2014, investors would wait and watch
for a clear direction to be given in terms of policy and economic
outlook. Therefore, there would be a delay of 3-4 months before
huge investment is committed. In the light of this, our projection for
growth for FY15 would be 5.5%-6%.
• Credit growth in the banking sector, which grew by 17-18% (y-o-y)
during August – October 2013, moderated significantly in December
2013- January 2014 period to 14-15%. Growth is, however,
expected to revive to 16-18% in 2HFY15, after the general elections
(albeit, on a decisive electoral mandate).
• Under such circumstances, tactically –
 for risk-averse investors it makes sense to remain closer to short
end of yield curve with Ultra ST Funds, short tenured FMPs
(preferable monthly interval plans) and ST Funds (with modified
duration of less than 3 years).
 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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5. 5
Jignesh Shah
Capital Advisors
+ 91 – 9820296989
jshah@capitaladvisors.co.in
Contact Details

6. 6
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