Suyash Choudhary

The RBI cut repo rate by 25 bps to 7.25% as was expected by consensus. There was no change to  CRR. HTM has been cut by 2% to be implemented in gradually in 50 bps moves every quarter starting June. Besides, the following indicative projections for various macro-parameters were given for the year:



– GDP for 2013 – 14 pegged at 5.7%

– RBI to endeavor to condition evolution of inflation to level of 5% by March 2014. Importantly, this is not a projection as is traditionally given but seems more like a ‘statement of intent’

– M3 growth for 2013 – 14 projected at 13%, and deposit growth at 14%

– Growth in non-food credit projected at 15%.


The policy and the pre-policy document before it, underscores largely the same points that the RBI has been making consistently over the past few months.  These are largely as follows:


– Growth is a major concern but hinges to a large extent on investment revival. Here, the RBI’s incremental role is limited and in fact previous rate cuts have also not had much impact. Rather, the government has a much larger role in terms of focusing on relieving supply bottlenecks, better governance and continued focus on fiscal consolidation. RBI has gone in considerable detail as to where all supply bottlenecks exist including in coal and electricity generation, telecom, roads etc. While government has made tangible efforts towards fiscal consolidation, overall fiscal deficit is still high and there is risk of slippage due to revenue slowdown if growth remains subdued. Finally, the government has to allocate more spending on investments while reducing revenue expenditures so that overall fiscal deficit doesn’t rise.


– WPI inflation has fallen, core WPI even more so reflecting subdued commodities, stable rupee, and lack of pricing power. However, pass through pressures may arise from coal, electricity and diesel as these adjustments continue. Furthermore, food inflation still remains high. Most importantly, CPI remains in double digit thereby causing ‘wedge’ between CPI and WPI to widen further. The new input in this discussion in this policy seems to be RBI’s determination to bring WPI towards its threshold of 5%. This suggests that the central bank doesn’t perceive that the recent fall in WPI (and more to come in months ahead) necessarily provides much more room to monetary policy. In fact the indicated trajectory builds for WPI to be range-bound around 5.5% with some undershooting in first half of the fiscal and some increase in the second half.


– External risks as first focused upon in January remain a primary concern; notwithstanding recent fall in trade deficit and softer commodities indicating further narrowing ahead. The RBI’s comfort on current account deficit (CAD) is towards 2.5% of GDP. The worry, so far as the deficit is much higher, is that of sudden changes in capital flows to the country.


Given all of these, the RBI assesses ‘little space for further monetary easing’. In fact it even says that risks from CAD and its financing could ‘warrant a swift reversal of the policy stance’.


Assessment and Implications

Even though RBI has sounded much more hawkish than general market expectations, the developments today are very much in line with RBI’s recent framework the way we have interpreted it.  This framework suggests a shift somewhat from the traditional growth versus inflation trade-off towards thinking about actual real world utility of further rate cuts. We had indicated some of these counterpoints recently (refer our note “The counter-logic to current interest rate expectations” dated 29th April). If anything the RBI has tightened its framework more today given that it wants to condition market towards 5% WPI inflation. To recall, a sharp fall in WPI inflation recently is the largest driver currently for market’s future rate cut expectations. However, if the central bank seriously pursues a 5% WPI conditioning, then actual prints have to start undershooting that mark as well for scope of rate cuts to open up. To be sure, the scope for even this happening exists over the next few inflation prints given the significant commodity price correction and loss of inflation momentum recently. Also, as we have seen over April, market memory is typically short and the current RBI hawkishness may soon be forgotten in face of continued weakening of economic data. For this reason, government bond yields may be better supported even in the face of supply than the pure implication from today’s assessment may suggest.


However, the point is really very different. Barring a brief move towards 8%, government bond yields have been stuck between 7.75 – 85% now since February. This is largely because the period of limited  net supply of government bonds since late last year has given way with fresh supply starting from April. In the same period, front end corporate bond yields have come off by upwards of 50 bps. This is in line with our expectations and our underlying hypothesis that we would rather play ‘seasonality’ than rate cuts given the extra-ordinary nature of this cycle. While we remain overweight 1 – 5 year in our bond funds for now, we may gradually look to build further on longer end (government and corporate bonds) as additional supply kicks in over the next few months. Meanwhile, we would reiterate recent advise to investors to match risk appetite and investment horizon to their investment decisions; irrespective of short bursts of performance from various categories of fixed income funds.


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