Emkay: Mid Quarter Monetary Policy; Uncertainty prompts inaction; hikes to follow tapering

Monetary Policy

Uncertainty prompts inaction, hikes to follow tapering

RBI's decision to hold rates and the mention to announce off-policy action if need be, suggests RBI buying time ahead of Fed's impending decision on QE tapering. A status quo against consensus expectation of 25 bp Repo rate hike, amidst steep inflation rates is a dent to the credibility of the repeated hawkish articulation by RBI. While being hopeful on several short-term indicators to provide comfort on inflation, RBI's inaction misses foresight and further indicates of a reactive future action as and when the situation demands (read FOMC tapering). Going forward we expect RBI reacting with further rate hikes in response to higher than desirable inflation and renewed currency volatility.

Policy action rationale:

RBI holds rates: Contemplating the growth inflation dynamics, RBI perceived the policy call as a close one and chose to stay put at rates

* Why a pause? Buying time before action: RBI justifies its inaction based on expectations of some softening in inflation based on a) lower vegetable prices going ahead b) disinflationary impact of recent exchange rate stability c) negative output gap and d) lagged impact of earlier monetary tightening. The RBI refrains from 'overly reactive' action to recent upsurge in inflation numbers as growth remains very weak

* However we believe, the RBI has chosen to buy time ahead of FOMC's meet scheduled 17-18th Dec and created a cushion to announce off-policy rate action as any announcement on the QE tapering would result in significant financial market volatility and impart substantial depreciation pressures on the INR. Rate tightening to sustain the capital flows and contain INR volatility would then be imperative

Outlook—Rate tightening to continue:

RBI cautious of its inaction: RBI seems to be cognizant that its inaction risks an outcome of even higher inflation. Its conviction of inflation rate easing on the back of recent softening in vegetable prices is weak and uncertain. In addition, RBI also leaves space for uncertainty around whether Fed will start tapering on Dec 18 or not. At this juncture given multiple uncertainties RBI does not want to over-react.

- In the near term condition under which RBI may sustain inaction include a) significant decline in inflation (say 50-100bp) on expected decline in veg prices, b) decline in ex-food inflation & c) Fed does not initiate tapering. However, with RBI reiterating the inevitability of tapering and its view that CPI inflation will remain high notwithstanding the recent decline in wholesale prices of vegetables is a clear indication that RBI is ready to raise rates at an appropriate time.

- RBI is also assuming significant fiscal tightening in Q4FY14 and hence, slower growth and inflation impetus thereof. This looks optimistic in the context of 18.1% expansion in total government spending during Apr-Oct'13 and the upcoming general elections

- In our view, the wait and watch approach trivializes the fact that food inflation collectively has persisted at very high levels over the past 7 years (averaging at 10.6%) and should not be contextualized to short price data flow on few items

Rates to remain elevated: Weak growth fundamentals juxtaposed with sustained price pressures complicate RBI's decision making. Going forward, we believe, elevated inflation and renewed currency volatility could imply rate hikes announcements by the RBI. We expect the rate-tightening cycle to continue and expect 50bp hike in repo rate in the next 6 months.

Source : Equity Bulls

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