1QFY2014 Monetary Policy Preview - Angel Broking

In addition to the growth-inflation dynamics the RBI's monetary policy stance is likely to be determined by developments in the external sector owing the sharp depreciation of the INR. In view of this, we believe that the RBI is likely to maintain status quo on policy rates in its policy meeting on July 30, 2013. The INR has depreciated by nearly 10% since May 2013. Consequently, the RBI's tone remains cautionary against the risks of elevated twin deficits, reversal of capital flows and imported inflation gaining ground and mitigating the beneficial impact of softening global commodity prices.

During June 2013, WPI inflation has remained in the RBI's comfort zone for the third straight month and core inflation collapsed to a 42-month low. In addition, growth indicators have remained sluggish without signs of sustained improvement. Growth during FY2013 has slumped to a decade-low of 5.0%. The IIP for May 2013 reported a 1.6% decline in industrial production. Industrial activity reported almost flat 0.1% growth during April - May 2013 as against 0.6% growth in the corresponding period of the previous year. The sluggishness in economic growth along with decelerating inflation warrants a supportive monetary policy stance. In contrast however, owing to our external sector vulnerability the RBI has taken some strong measures during July 2013 to contain exchange rate volatility by squeezing liquidity which can be viewed as monetary policy tightening through stealth.

The steps taken by the RBI include 1) prohibiting banks from proprietary trading of currency futures, 2) capping borrowing of banks from the LAF window to 0.5% of each individual bank's NDTL, 3) hike in the MSF and bank rate by 200bp raising the cost of excess borrowing to 10.25%, 4) maintaining a minimum daily Cash Reserve Ratio (CRR) balance of 99% of the prescribed requirement up from a minimum of 70% mandated earlier and 5) announcing open market sales of Gsecs amounting to Rs. 12,000 crores.

Since the RBI has already taken such stringent measures to constrict liquidity in the system, we do not expect the RBI to go a step further and hike the CRR at least for now. Presently the policy rate - repo stands at 7.25%, reverse repo at 6.25% while the penal emergency lending rate - MSF/ bank rate stand at 10.25% and CRR is at 4.0% of bank's NDTL.

Source : Equity Bulls

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