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MidQuarterReviewof MonetaryPolicy
March15,2012
ICRONRESEARCHDESK

MidQuarterReviewofMonetaryPolicy March15,2012

RBIkeptkeypolicyratesunchanged,nopositivesurpriseforthemarkets
TheCentralBankkeptpolicyreporateunchangedat8.50%. Consequently,thereversereporemainedunchangedat7.50%andmarginalstandingfacility (MSF)rateandthebankrateat9.50%. TheRBIkepttheCashReserveRatio(CRR)unchangedat4.75%afteritwasreducedby75 bpsonMarch9toaddressthepersistentstructuraldeficitbeyondthecomfortlevel. TheperformanceofGDPin4QFY12isexpectedtobebetterthanthelastquarterfigureof 6.1%. Inflationalthoughmoderatedlatelybutupsideriskmightevolveduetohigherglobalcrude oilprices,coupledwithhigherfiscaldeficit. Interestrateshavepickedandfutureactionswouldbetowardsloweringofrates.

Overview: Thecurrentpolicyreviewwassupposedtobeanoneventaftertheinflationdata.Thetone of the statement was rather cautious as higher freight rates, announced by Railways, and global commodity prices would push up inflation in coming months. Though people here are arguing whether 6.50%7.00% is a good rate of growth or not, however, it is indeed a very handsome return for foreign investors. The liquidity generated through long term refinancing operations (LTRO) is slated to flow to emerging economies like India. The banking system is facing structural liquidity deficit and to improve that, the RBI hasalreadyslashedcashreserveratio(CRR)bY125basispoints. Rationale: To combat with the rising inflation rate, the RBI has raised the key interest rates thirteen times consecutively, which in turn, has adversely impacted the growth trajectory of the economy. The GDP for the third quarter plungedto6.1%,thelowestinlasttwoyears. Ontheotherhand,despitecoolingeffect,the inflation moved up to 6.95% in February as against 6.55% reported a month ago but it still remained below the central bank's end Marchprojectionof7%.Foodarticleindex,afterremainingatsubduedrateof0.79%and()0.52% forlastcoupleofmonths,suddenlysurgedto6.07%inthemonthofFebruary.RBIsdecisiontokeep the rates unchanged after October review has supported the IIP number and it has improved gradually.WhileinOctober,IIPmovedtonegativeterrainat4.74%,itrecoveredandstoodat6.8% in January, the strongest in last seven months. Thus with the decision of keeping the policy rates unchangedandreducingtheCRR,RBIhasmadeitsintentionclearofbringingtheAsiasthirdlargest economybackonthegrowthpathandgivingaboosttothemacroeconomy. ICRAOnlineLimited

MidQuarterReviewofMonetaryPolicy March15,2012
Themainreasonsbehindthismove The slippage in the fiscal deficit is adding to inflationary pressures, credible fiscal consolidation would be an important factor in shaping the inflation outlook. The Union Budgetwouldbeimportantasfiscaldeficitnumbersandgrossmarketborrowingswouldbe keenlywatchedbyRBIandmarkets. Afterraisingthekeypolicyratesinpastquarters,liquiditycrunchwasseenintheeconomy, whichadverselyimpactedthesupplyside.KeepingthepolicyratesunchangedinDecember and slashing the CRR in January, RBI tried to bring the economy out of poor liquidity situation. Moreover, with no bond auction scheduled till the first week of April and huge redemptionslinedup,bondyieldsandliquiditysituationarelikelytoimproveinshortterm. MarketwasexpectingareversepolicymeasurebyRBIinthiscurrentfiscalwhich,however, wasnotpossibleafterseeingtheglobalmacroeconomicsituation.Inflationstillremaineda causeofconcernforRBIduetorisingglobalcrudeprices. Huge fiscal deficit of the government became a matter of concern for RBI. With higher oil and fertilizer subsidy, it has breached the targeted level of 4.6% of GDP in the first ten months of the year and it is expected to widen further in the next two months. Thus to finance the deficit, RBI prints notes to lend to the government, which in turn, raises the moneysupplyintheeconomy.Withhighermoneysupply,inflationwouldalsomovesnorth ward and would affect the economy adversely. Thus the economy, as a whole, is trapped under the vicious cycle of liquidity crunch. With the cut in CRR, RBI has tried to seek a primaryandpermanentinstrumentofcreditcontrol. Intheglobalfront,recoveryintheUSeconomycoupledwithliquidityinjectionbyECBhas mitigated some pressure on the financial market. However, rise of commodity prices following conflict between Iran and the US might create some uncomfortable situation in theglobalframework. MarketReactions:

ThepolicystatementbyRBIalwaysimpactsboththeequityanddebtmarkets.Asthetableabove shows,themarketsentimentschangeswiththepolicystatement.Inthecurrentquarter,themarket wasexpectinga25bpsreductioninthekeypolicyrates,henceboththebroadermarketandBankex ICRAOnlineLimited

MidQuarterReviewofMonetaryPolicy March15,2012
wentup.However,assoonasthestatementshowednochangesinthekeyinterestrates,profit bookingssentmarketbackinred. Thebarometerindex,BSESensex,wasdown227.03pointsor1.27%,upcloseto70points from the day's low and off close to 220 points from the day's high after the RBI kept key interest rates unchanged in its policy review, putting to rest hopes that the central bank couldsurprisemarketswithmonetaryeasing. AllthesectoralindicesatBSEwereinredexceptIT.Ratesensitivesectorsreactednegatively due to profit booking. Consumer Durables (3.66%), Realty (2.66%) and Bankex (2.60%) weretheworstperformingsectors. The rupee was at 50.22/23 per dollar, weaker than Wednesday's close of 49.91/92, as demandofdollarfromgoldimportersweighed. Theyieldonthe10yearbenchmark8.79%2021bondroseto8.36%from8.29%afterthe RBIleftkeypolicyratesunchanged. Outlook: The Central Bank did not give a positive surprise to the market and kept the key policy rates unchanged as the inflation risks have not completely disappeared. The Union Budget would be a crucialeventandalleyeswouldbeonfiscaldeficitandgrossmarketborrowingsnumber.Inthenext monetarypolicy,itisexpectedthatRBIwillreducethekeyinterestratesby25bpsandkeeptheCRR ratesunchangedascutof125bpshasalreadyinjectedliquidityworthRs.70,000crore.
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