24th January 2011 Third Quarter Credit Policy Preview

ECONOMOIC REPORT
The Reserve Bank of India will be announcing its third quarter review of Monetary Policy 2010-
11 tomorrow, January 25th 2011. The majority of the street is expecting the following changes
in the key rates:

Policy Rate Existing Expected Hike Final Rate

Repo Rate 6.25% 25 bps 6.5%

Reverse Repo Rate 6.25% 25 bps 6.5%

CRR 6.00% No Hike Expected 6.00%

SLR 24.00% No Hike Expected 24.00%

RBI today at 5 p.m. has released its review of macroeconomic and monetary developments for
the third quarter which serves as a background to the monetary policy.

Some of the Key Highlights of the document which we believe will set the tone of the monetary
policy tomorrow are:

 RBI mentions that “While downside risks to growth have receded, upside risks to inflation have
increased” and “since a lower inflation regime is essential for sustainable high growth, containing
inflation becomes the dominant policy objective in the current environment”

 Emerging Market Economies (EMEs) face the risk of inflation from strong growth and hardening of
commodity prices

 The robust GDP growth in the first half of 2010-11 suggests that the economy has returned to its earlier
high growth path

 Upside risks to inflation from structural demand-supply imbalance in certain sectors and hardening global
commodity prices have increased

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 Since persistent high inflation could endanger the growth objective and also amplify risks to inclusive

ECONOMIC REPORT
growth, containing inflation will have to be the predominant objective of monetary policy in the near-
term

 Several banks also revised their base rates upwards in the range of 25-100 basis points during July 2010 -
January 17, 2011, and the associated increase in effective lending rates could be expected to contain
demand pressures, going forward.

 Higher net capital inflows did not pose any immediate challenge, unlike in many other EMEs, because of
the widening deficit in the current account

MPA Analysis:

The third quarter macroeconomic and monetary development document published by the RBI
clearly sets the tone for tomorrow’s policy announcement. In nut shell the policy will be
based on the analysis that even though the growth is on track, there remains considerable risk
to the growth because of the increased inflation which RBI will try to tackle dominantly.

Even though the general street expectations are of a 25 bps hike in the Repo and Reverse
Repo rates we believe that the way RBI has placed inflation throughout its macroeconomic
and monetary development report today, we believe that a 50 bps hike is very much likely.

Banking stocks have given a decent rally today with Bank Nifty Index up by around 2.4%
against only a 0.8% rise in Nifty, however we believe that long positions in the banking
stocks in specific and other rate sensitive stocks like auto, cement and steel should be avoided
as any more than expected hike in the key rates could possibly lead to their sell off.

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 ECONOMIC REPORT
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