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Economy
Monetary Policy
RBI Monetary Policy: Catching the bull by the horns. In this policy review, RBI
focused on its ‘liquidity management’ objective as it took important steps to address the
ongoing liquidity crunch in a more tangible manner. RBI announced OMO auctions to
the tune of Rs480 bn and backed it by announcing a calendar for these operations,
thereby removing the uncertainty on liquidity (Rs120 bn each week starting from the
week ending December 24). RBI also announced a permanent SLR cut by 1% to 24%,
which will help banks to lend more but does not tantamount to a liquidity infusion.
Repo and Reverse Repo rates remain unchanged at 6.25% and 5.25%, respectively,
while CRR stays at 6%.
Key rates left unchanged; SLR cut to 24%, OMO auction calendar of Rs480 bn
RBI in the mid-quarter meeting today paused for the first time since the rate hike cycle began in
March 2010. The effective hike amounted to 300 bps as the operative rate changed from the
Reverse Repo mode to the Repo mode. In the November 2 meeting, RBI had indicted: ‘The
likelihood of further rate actions in the immediate future is relatively low’. Hence, today’s rate
decisions do not come as a surprise to us. With liquidity in a very tight zone, markets hoped RBI
would provide some leeway with direct liquidity easing measures such as reducing the CRR.
However, RBI had been pointing out that its anti-inflationary policy stance has not changed and
hence CRR did not suit the purpose. Instead OMO was announced, amounting to an equivalent of
nearly 1% CRR reduction and will serve the purpose similarly. The uncertainty factor on liquidity
injection was also removed by announcing a calendar on the OMO auctions. RBI also announced a
SLR cut of 1% with additional support under LAF to the extent of 1% of NDTL till January 28,
2011 (previously 2%).
Bond market rallies on improving liquidity environment
Consequent to the OMO announcement we have reworked our monthly liquidity projections (see
Economy note on November 30: “RBI extends its ad-hoc liquidity easing measures as crunch
persists”). The liquidity situation now shows significant improvements in February and March 2011
(more crucially within the upper bound of 1% of NDTL). This is likely to ease the pressure on
overnight money market rates and also gradually lead to a fall in the current high CD rates. The
1% reduction in the SLR should have generally been negative for the G-Sec market. However, as
the markets were more focused on liquidity measures from RBI, the OMO measures along with the
SLR announcement has led to the yield on the 10-year benchmark paper (7.80% GS2020) to drop
to 7.98% from 8.07% previous close. Yield on the more liquid 8.13% GS2022 moved down to
8.01% from 8.07% in previous close. We continue to expect the 10-year benchmark to trade at a
lower yield in 4QFY11E.
Inflation continues to be a concern; we stick to our call of 25 bps hike in Repo and Reverse Repo
rates in January
The policy communiqué highlights the fact that inflationary pressures persist due to domestic
demand and higher global commodity prices. Food articles on a weekly basis have seen inflation
coming down to single digits but not at a pace that would be desirable. Vegetables and proteinbased foods continue to experience double-digit inflation. Non-food manufactured products
inflation continues to remain sticky at around 5-5.4%, indicative of the demand-side pressures in
the economy. High crude prices and commodity prices might feed into domestic inflation and keep
inflation above RBI’s expectation (we expect end-FY2011E at 6.25-6.5% with upside risks from
higher domestic fuel prices). Consequently, real interest rates still remain in the red and need to
move into the positive zone given the strong demand and low deposit growth. Thus we look at
RBI to hike the Repo and Reverse Repo rates by another 25 bps each before end-FY2011E.
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