Santosh Kamath, CIO - Fixed Income, Franklin Templeton Investments - India
At its third quarter review of FY14 monetary policy, RBI has hiked the repo rate by 25 bps to 8% and kept the CRR rate unchanged (4%). The reverse repo rate accordingly stands adjusted to 7% and the MSF and the bank rate move up to 9%. Key points from the policy update are -Inflation: A shift in emphasis from wholesale inflation to consumer price inflation and core inflation rates (i.e. ex food and fuel) is visible. The central bank believes there is increasing need to bring down inflationary expectations in order to create a conducive environment for growth in a sustained manner.
Economic Growth: The third quarter is likely to have witnessed a loss of growth momentum and India may close FY14 with GDP growth slightly below the 5% mark. A gradual recovery is expected to take place in FY15 and growth to range between 5-6% (depending on global factors as well as the pace of investment recovery).
External Position: The central bank has reiterated that India remains relatively well placed in the current environment, notwithstanding the pressure on EM countries. Forex reserves have been bolstered by the various RBI measures and this along with reducing current account deficit point towards comfortable fundamentals over the near term. Current account deficit is expected to narrow to 2.5% of GDP from 4.8% last year. Also repayment by oil marketing companies as their forex swaps expire should bolster the reserves and further portfolio inflows could augment the external situation.
Liquidity: Given the need to ensure adequate credit flow to productive sectors, RBI is expected to actively manage liquidity in the near term - possibly through a combination of OMOs and term repo auctions.
Prudential Measures: RBI is looking to support growth trends through its moves to enhance market infrastructure, increase financial inclusion and plug systemic risks - cash-settled interest rate futures, framework to address problem assets, and new monetary policy framework.
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The policy took a large section of the markets by surprise and yields moved up, but the future guidance statement helped in calming the nerves. We continue to adopt a cautious stance - monetary policy actions are likely to be driven by both local as well as global factors. The focus on inflation targeting could be viewed as a positive development, as that enhances policy transparency. However, we continue to believe that higher rates alone are not a panacea for inflation and that structural issues need to be dealt through fundamental reforms. This is essential if India has to transition to a higher growth trajectory on a sustainable basis.
Notwithstanding the recent moderation in food inflation, we believe there is a need to focus on medium term trends rather than near term data points. While the high base effect might help with headline inflation data, there remains concern about food inflation and wage pressures due to indexation. RBI surveys have pointed towards entrenchment of high inflationary expectations. A lot depends on the global commodity prices and a slowdown in the Chinese economy could help. In its recent policy framework paper, the central bank appointed committee has suggested a move towards using CPI as a basis for monetary policy. Whilst there is discomfiture about the current CPI levels, the central bank comments indicate it is yet to evaluate the committee's recommendations and finalize approach. Meanwhile, the policy statement indicates that further tightening might not take place, if inflation data comes in line with expectations. We also need to keep in mind that there is suppressed inflation in the economy as fuel prices in India are still not fully aligned to global price movement.
Markets are likely to closely follow incoming economic data in coming weeks and developments on the new policy framework. Latest news flow on divestment, spectrum auctions and public sector dividends suggests the government is likely to meet the fiscal deficit targets, despite low tax revenue growth. We continue to believe that accrual focused funds can help investors navigate the current uncertain environment. Investors with higher risk appetite and longer term horizon can look at long dated/gilt focused funds.
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