Review of Monetary Policy: August 2015 - Mr. Sivakumar, Head Fixed Income - Axis AMC

Review of Monetary Policy: August 2015

The Reserve Bank of India left the benchmark repo rate unchanged in its bimonthly policy review. The repo rate was unchanged at 7.25%. In its statement the RBI indicated that the previous rate cuts of 75 basis points were front loaded and it was prudent to wait for transmission of these cuts by banks. In the last policy the RBI had indicated some key risks several of which have since reduced. The price of oil has fallen to near its lows early in the year and relatively small increases in minimum support prices of crops should keep food inflation contained.

The impending resolution of the Greek crisis and the fact that it has not had a spillover impact on the global markets also provides some comfort to the RBI. However the slowdown in China may have a larger impact in the months ahead. For now the Chinese slowdown is having a positive impact in terms of lower commodity prices - which has a positive impact on inflation and the current account. The US Federal Reserve has indicated that it would increase rates from a historic low in the near term. The experience of 2013 suggests that changes in policy by the Fed could have a significant impact on global markets - mainly through currency movements. As of now the rupee has been stable though the RBI would like to wait for the Fed to judge the impact it has on markets.

In addition to these factors the Reserve Bank is also awaiting transmission of past rate cuts into lending rates of banks. As against a 75bps reduction in the benchmark rate, the median base rate of banks has fallen by 30 bps since January. Lending rates have been slow to fall despite lower repo rate and falling bank credit growth. It would appear that the RBI is looking for further evidence of transmission of lower rates to the commercial sector.

Looking forward, the RBI now expects year-end inflation to be lower by about 0.2 percentage points (from the previous level of 6.0%). The lower inflation projection reflects lower oil and commodity prices and a near normal monsoon so far. The reduction in inflation projection could open space for further rate cuts in the months ahead, while the timing may be dependent on further evolution of inflation numbers and the US Fed's actions. For the bond markets a challenge has been that foreign portfolio investor limits on investments in government securities have been full for nearly a year. In view of the strength of the rupee and the potential volatility of flows, the RBI has been wary of large increases in the FPI limit. The RBI announced that it is in process of setting up a framework for regular review of the limit with a view to bringing in more long term money from investors such as pension funds and sovereign wealth funds along with other market participants. This will further improve the demand for bonds in the local market.

The bond markets had largely anticipated that the RBI would be on hold in this policy. Thus there has been a limited impact on the markets today. Going forward we expect that lower inflation and growth relative to potential will allow rates to be further reduced in the medium term. As such we continue to maintain a longer duration stance across our portfolios.

Source : Equity Bulls

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