In a surprise move, in its mid-quarter monetary policy review, the Reserve Bank of India (RBI) left repo rate and CRR unchanged. The central bank believes that interest rates are only a small factor in the current economic downturn, and worries that supply bottlenecks and sticky inflation expectations are keeping up headline inflation.
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In our view, RBI has already succeeded in curbing demand-led inflation, and the economy has slipped far below potential. In such a scenario, keeping policy tight to address headline inflation could prove counter-productive. Fiscal deficit would worsen further (as tax revenue falters due to weakening growth), investment slowdown would deepen and inflation could remain sticky (due to lack of capacity creation). Accordingly, in our view, Mint Street should undertake about 75-100bps easing in rest of FY13.
Regards,
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