RBI holds rates as expected; policy guidance is dovish - ICICI Bank : Treasury Research

In the policy review, the RBI kept the key policy rates i.e. repo rate and CRR unchanged at 7.25% and 4% respectively in line with our expectations. The policy guidance that was closely watched indicated that the Central Bank would "roll back the recent slew of liquidity tightening measures in a calibrated manner as stability is restored in the foreign exchange market". Moreover, the withdrawal of these measures would "enable the monetary policy to revert to supporting growth with continuing vigil on inflation".

Growth inflation dynamics to remain focus for monetary policy

Growth concerns have been rising

RBI has revised down FY2014 GDP growth projection to 5.5% YoY from 5.7% YoY previously, amidst heightened risks from industrial sector weakness, in spite of robust monsoon.

Inflation trajectory has evolved as per expectations though risks remain

The inflation prints in Q1 came out as expectations. However, the food inflation has not yet moderated in spite of good start to monsoons. The pass-through of Rupee depreciation poses upside risks to inflation.

Meanwhile, RBI has kept the inflation projection unchanged at 5.50% and would continue to endeavour to condition the evolution of inflation to a level of 5.0% by March 2014.

Monetary policy remains vigilant regarding external sector risks

Domestic external vulnerability indicators have deteriorated

The RBI has clearly highlighted that current account deficit above 2.5% of GDP is a structural risk for the economy. Stable financing of CAD is also a cause for concern.

The turmoil witnessed in the global markets on Fed QE tapering concerns has led the RBI to adopt a liquidity tightening stance. The guidance clearly signals that these measures are essentially temporary in nature and would be withdrawn once stability is ensured in the exchange rate market.

Definition of stability of FX markets remains crucial

The PM's economic adviser Rangarajan believes that a revival in capital inflows would be construed as return of FX market stability.

RBI would face a growth - currency tradeoff in determining timing of withdrawal of the liquidity measures. If continued for a long time, they risk having adverse growth implications.

Timing for rollback contingent on FX market stability

Domestic external vulnerability indicators have deteriorated

The RBI has provided some relief in its first statement indicating a possible roll back of the liquidity tightening measures to contain FX market volatility. However, the timing of the rollback would be crucial to determine, with the RBI likely to assess the Fed policy stance in the upcoming FOMC meetings, to assess the FX market conditions.

We await announcements from the Government with regards to financing of CAD through issuance of NRI bonds or other steps to sustain the recent Rupee appreciation.

On the monetary policy front, we believe that repo rate changes would be deferred till tightening measures are withdrawn. However, given the rising growth concerns and contingent on exchange rate stability, we believe that the RBI may only consider easing in the latter part of the fiscal.

Source : Equity Bulls

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