RBI Monetary Policy - Jan 2013

Monetary Measures
	a.	The policy rate i.e. Repo Rate cut by 25 bps from 8% to 7.75% with immediate effect.
	b.	Consequently, the reverse repo rate under the Liquidity Adjustment Facility (LAF) and the Marginal Standing Facility (MSF) stands reduced to 6.75 % and 8.75% respectively.
	c.	The Cash Reserve Ratio (CRR) has been cut by 25 bps from 4.25% to 4.00% w.e.f. 9th February 2013, infusing around Rs.180Bn of primary liquidity in to the system.
	RATONALE BEHIND THE CUT IN POLICY RATES
	a.	Moderating trend in Inflation - Both the headline wholesale price inflation and its core component, non-food manufactured products inflation, have indicated softening trend. Further, indications of weaker pricing power of corporate, the negative output gap in some sector and the stable international commodity prices indicates inflationary pressures have peaked.
	b.	Slowing Growth - Growth has decelerated significantly below trend in the last 2 years, and overall economic activity remains subdued. The investment activity has been way below desired levels and consumption demand too has started to decelerate.
	c.	Tight Liquidity Condition – The liquidity conditions have remained tight. Although the RBI lowered the CRR, successively in September and October 2012, and carried out Open Market Operations (OMO) injecting systemic liquidity of 470 billion during December and January to augment liquidity, the current average net LAF borrowings at Rs. 910 billion is well above the Reserve Bank’s comfort level.
	INFLATION PROJECTION FOR FY13 REVISED DOWNWARDS FROM 7.5% TO 6.8%
	Taking comfort from the recent moderation in inflation trend, particularly core inflation, RBI has revised downward the baseline WPI inflation projection for March 2013 to 6.80% from its earlier projection of 7.5%. Despite this, the RBI has been more conservative on the inflation trajectory going forward, emphasizing ‘upside risks from suppressed inflation which could impart stickiness to inflation trajectory in FY14.
	M3 GROWTH PROJECTION REVISED DOWNWARDS
	RBI has noted that due to slow growth in deposit and moderation in economic activity, the M3 growth has remained well below the projected trajectory of 14%, while the non-food credit growth has been in line with its indicated projection of 16%. Keeping in view the seasonal pattern for the last quarter, RBI has scaled down the M3 growth projection for FY13 at 13% from the earlier target of 14% while non-food credit growth projection is retained at 16.0 %.
	GDP GROWTH PROJECTION – REVISED DOWNWARDS FROM 5.8% TO 5.5%
	RBI in its First Quarter Review of July 2012 had indicated a GDP growth of 6.5%, which was later revised downward to 5.8% in its October policy review, due to increasing global risk and accentuated domestic risks on account of halted investment demand, moderation in consumption spending and erosion in export performance. RBI has now scaled down the growth projection even lower to 5.5%, citing the subdued industrial activity and sluggish external demand.
	FUTURE TRAJECTORY OF THE POLICY ACTIONS
	With growth becoming the primary target of RBI the guidance for monetary policy is predictably for lower rates. However, RBI has stressed that the scope for rate cuts is limited. It has noted that, the growth impetus rest on broader policy reform and the fiscal and current account deficits will need to moderate. Given the constraints, we expect that the RBI is unlikely to tread the path of continuous rate cuts and may ease the rates in a non-linear manner, as in the present instance, which it did after a gap of over 10 months.
	IMPACT ON THE BOND MARKET
	The sovereign bond market which opened weaker, due to less than expected dovish comments in the RBI’s Policy pre-view document released yesterday, reacted positively to the policy announcement. The benchmark 10 year sovereign bond yield which had moved up 4 bps compared to previous day’s close, recovered the lost ground on policy announcement and is presently trading around 7.85%. We expect the benchmark 10 year sovereign bond yield to trade in a range of 7.80-7.90% going forward.