Predictably, rate-sensitive indices led the way for a rise in the broader indices as the Reserve Bank of India (RBI) again emphasised a peaking of the interest rate cycle in its review of the Monetary Policy today.
The RBI Governor reinforced the guidance that further policy actions would most likely reverse the cycle by lowering policy rates. The central bank cut Cash Reserve Ratio (CRR) maintained by banks by 50 basis points (bps) to 5.5% of their net demand and time liabilities (NDTL) effective from January 28, 2012 that would release about Rs 32,000 crore into the banking system.
The move would reduce liquidity pressure which, the Governor stated, has been tight and beyond the RBI’s comfort zone of 1% of NDTL with a net liquidity injection of over Rs 70,000 crore by the RBI through open market purchase of government securities.
The policy stance was influenced by this significant increase in the structural deficit in the system which, according to the RBI, could hurt the credit flow to productive sectors of the economy. This, therefore, necessitated a permanent primary liquidity injection into the system especially ahead of further stresses expected from upcoming advance tax outflows.
Slowing Growth
While keeping the key policy repo and reverse repo rates unchanged at 8.5 and 7.5%, the RBI noted that growth is decelerating and inflation is moderating and therefore the next policy action would most likely cut rates.
The slowing growth reflects the combined impact an uncertain global environment, the net impact of past monetary policy tightening and domestic policy uncertainties. With credit offtake below projected trajectory, the RBI lowered its GDP growth projection for FY12 from 7.6% to 7% and stated that risks to growth have increased.
It noted that although headline WPI inflation is moderating, this largely reflects a sharp softening in prices of seasonal food items. In contrast, inflation of other key components, particularly protein-based food items and non-food manufactured products continued to be high. The upside risks to inflation were due to global crude oil prices, impact of rupee depreciation and fiscal deficit slippages.
| HOW THE INDICES HAVE MOVED | |||||
| Change (%) | |||||
| 1-day | 1-month | 6-months | |||
| BSE Auto | 1.35 | 7.01 | 0.03 | ||
| BSE Bankex | 2.71 | 14.75 | -15.29 | ||
| BSE Consumer Goods | 3.43 | 21.11 | -27.93 | ||
| BSE Realty | 0.68 | 20.60 | -21.89 | ||
| 1-day change is as on Jan 24, 1-mth and 6-mth change is as on Jan 23 | |||||
The Road Ahead
While this shift in the GDP growth and inflation balance has led to a predictably dovish tone to the monetary policy guidance, the RBI has cautioned that future rate actions depend on policy and administrative actions towards fiscal consolidation.
The projected government borrowing in the second half suggests a fiscal deficit much higher than projected in the Union Budget, which contributes to inflationary pressures while simultaneously crowding out private credit. Therefore, economists don’t expect any real action before the Union Budget announcement slated for March 2012 close to the end of this fiscal.
Arun Singh, Senior Economist, Dun & Bradstreet believes that any policy rate cuts will only come after April 2012 when the inflation scenario becomes clear. The impact of the rate hikes on non-food (manufacturing) inflation will be evident by then and therefore the March inflation print will be significant. A number close to 6 per cent will provide comfort for the RBI to proceed with rate cuts in its April 2012 monetary policy review, he says. While the IIP moderation is a concern, he doesn’t expect it to go into the negative zone but it could be subdued, below 5 per cent levels, for the next four to five months and normalize post rate cuts. Implementation of reforms by the government will be key as sluggishness here has been hurting sentiment, he adds pointing out that the Budget will be key going ahead.