Relieved to see RBI diluting tightening measures: BoAML

The central bank needs to inject Rs 1,500 billion to fund growth, says the report

With the RBI diluting its 15 July tightening measure, Bank of America Merrill Lynch has said that it is relieved to see this move.

"This supports our standing call that the road to rupee stability lies through recouping forex reserves rather than rate hikes," said Indranil Sen Gupta, India Economist at DSP Merrill Lynch (India) in a note.

We are pleased that the RBI has resumed OMO purchases (Rs 80 billion of gilts on August 23) to reverse the spike in yields sparked by OMO sales announced on July 15, the report said. It added that although a major argument in favor of tightening was to arrest the falling rate differential with the US10y to bring back FII debt inflows, this has expectedly not materialized due to the EM debt sell off.

Just as importantly, there is a crying need to step up M3 growth – now a bare 12.5% - with the busy industrial October-March season just 6 months away. On our part, we estimate that the RBI needs to inject Rs 1,500 billion via OMO to fund growth. This should pull down the 10y to about 8% by March 2014, factoring in a 0.8% of GDP fiscal slippage with depreciation pushing up the oil subsidy, the report said.

The report raised question whether diluting tightening will not weaken the INR? Not really, as the differential between the MSF rate and the Fed is at a record 1,000bp, it said.

Secondly, the $220 billion FII equity portfolio, which responds to growth, is much larger than the $30 billion FII debt portfolio, that may turn on rate hikes. Finally, we believe that the RBI will need to issue NRI or sovereign bonds to push import cover back to the 8-10 months critical for stability.