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STCI

15 Mar 2012

Primary Dealer Ltd

Amol Agrawal amol@stcipd.com +91-22-66202234

RBIs Mid-Quarter Monetary Policy Review: March 2012

In its Mid-Quarter Review of Monetary Policy Mar-12, RBI kept the policy rates unchanged. The policy decisions were in line with our expectations. Policy Rate changes Repo rate unchanged at 8.5% Reverse Repo rate and Marginal Standing Facility (MSF) Rate automatically stands unchanged at 7.5% and 9.5% respectively. Cash Reserve Ratio (CRR) unchanged at 4.75% of Net Demand and Time Liabilities (NDTL) Forward guidance statement Growth-inflation dynamics show that no further rate tightening is needed and future actions will be towards lowering the rates. The timing and magnitude of future rate actions depends on inflation outlook going forward.

I. Background to Policy Decision


Growth: RBI mentions that CSO has estimated GDP growth for 2011-12 at 6.9% which is in line with RBIs expectations. RBI has been highly concerned with decline in growth rate of investments. In the review, it again notes that the decline in GDP growth in Q3 2011-12 is mainly due to a deceleration in investment activity and weak external demand. On IIP trends, the Review says the growth has been lower in 2011-12 compared to 2010-11. As IIP trends have been very volatile RBI also looks at other trends to gauge business activity. Manufacturing PMI: In Feb-12 it shows industrial activity is robust. Corporate sales growth: In Q3 2011-12, though sales were robust margins had moderated. This indicates the corporates are finding it difficult to pass rising input prices. This could also be reflecting in core inflation which has moderated in recent months. Inflation: RBI notes that recent WPI inflation have trended lower in both headline and core inflation categories. RBI also takes into account the new CPI inflation series which showed Jan-12 inflation at 7.7%. Though it is a one time number, RBI says this indicates price pressures persist at the retail level. It is highly likely that CPI numbers will also form part of RBIs inflation analysis in future. RBIs continued concern over inflation is the highlight of this policy document. In the Jan-12 policy, it had mentioned that future policy actions depend on number of factors: it must be emphasised that the timing and magnitude of future rate actions is contingent on a number of factors. Policy and administrative actions, which induce investment that will help alleviate supply constraints in food and infrastructure, are critical. Initiatives to narrow skill mismatches in labour markets will help ease the pressure on wages. The anticipated fiscal slippage, which is caused largely by high levels of consumption spending by the government, poses a significant threat to both inflation management and, more broadly, to macroeconomic stability.
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STCI
15 Mar 2012

Primary Dealer Ltd

However, in this policy it just lists inflation as the factor for future rate actions (as mentioned above). Further, RBI mentions that upside risks to inflation have increased in recent times on account of following factors: Rise in crude oil prices on account of both geo-political concerns and abundant global liquidity Fiscal slippage Rupee depreciation Suppressed inflation in fuel, fertilizer and power because of administered prices in these products With this continued focus on inflation, the Review statement reads surprisingly more hawkish than expected by most analysts. Fiscal Situation: RBI mentions that fiscal conditions have deteriorated as key deficit indicators for Apr-Jan are over the budgeted estimates for full year. It reiterated that fiscal deficit has been adding to inflationary pressures and credible fiscal consolidation is important factor in shaping inflation outlook. External Sector: RBI raised concerns over widening current account deficit. The exports growth is lower because of weak external demand where imports are rising because of higher oil prices. Financing of CAD remains a challenge given the uncertain global situation.

II. RBI Policy Stance


Based on above economic outlook and background, RBI kept the policy rates unchanged. Though growth has come much lower, but inflation worries still remain for RBI. Pre-policy main concern was high deficit liquidity conditions and there were expectations of a cut in CRR. However, RBI lowered the CRR by 75 bps on 9-Mar-12 infusing liquidity worth Rs 48,000 Cr. This was done before the policy as new fortnight was to begin on 10-Mar-12. Announcing the CRR in policy would have either led to applying CRR rate on a prior date or in the next fortnight. The next fortnight begins on 24-Mar-12 and by then it would have been too late given liquidity was expected to tighten further on account of advance tax-flows. Having said this, liquidity conditions still remain tight. LAF repo borrowing in the last few days has averaged around 120,000 Cr -130,000 Cr higher than RBIs preferred target of around 1% of NDTL or about Rs.60,000 Cr. It is still possible that RBI does more OMO purchases in upcoming weeks.

III. Going Forward


RBI is expected to start easing policy rates at its Annual Policy 2012-13 on 17-Apr-12. Based on the economic trends so far, we expect RBI to begin easing policy rates in form of baby-steps of 25 bps. There is still a lot of uncertainty on inflation outlook especially from the crude oil front. Until RBI is very clear on the evolving inflation outlook and is reasonably sure that it will remain around RBIs preferred range of 5-5.5%, RBI likely to remain cautious. Union Budget for 2012-13 is extremely important as it needs to do multiple tasks of revising growth and investment sentiment, credible fiscal consolidation, rolling back subsidies etc. If the Budget does not deliver as per expectations, the denomination of policy rate cuts is likely to be much lower as well.

STCI
15 Mar 2012

Primary Dealer Ltd

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