Comments on the Monetary Policy - Aneesh Srivastava, CIO, IDBI Fortis Life Insurance

Currently, the RBI policy announcement read in conjunction with its statements indicates an aggressive tone of the RBI. We expect this tightening bias to continue in the current macroeconomic environment.

In an uncertain global macroeconomic environment, India has sustained its GDP growth at 7.4% last financial year and is expected to grow at 8.5% in the current financial year. Similarly, India's Industrial Production Index (IIP) has grown at 10.3% last year and in the current financial year, is averaging at 14% for the first two months. In this high growth environment, India's Wholesale Price Index (WPI) has shot up to a current level of 10.55% and Consumer Price Index (CPI) to 16.48%. The RBI had already increased Reverse Repo Rates from 3.25% to 4% and Repo Rates from 4.75% to 5.5%, both by 75 basis points prior to the current policy.

In such a high growth and high inflation environment India needs to tighten its monetary policy substantially to avoid over heating of the economy. When India achieved a GDP growth of 8.5% in March '08, its inflation was at 7.5%, Reverse Repo Rate was at 6%, Repo Rate was at 7.75% and CRR was at 7.5%. This means that an increase of 25 bps in the Repo (now at 5.75%) & 50 bps Reverse Repo rates (now at 4.50%) in the current policy is a small step towards higher rates in future if the domestic growth expectations are met. Considering a weak global economic environment, baby steps are necessary but would these steps continue in the future?

The Government has got Rs.68,000 crores from 3G auction, another Rs.38,000 crores from BWA and there was advance tax outflow of Rs.34,000 crores. Hence, a total of Rs.1,40,000 crores was absorbed from the system and this led LAF window of RBI to deficit mode to the extent of Rs.82,000 crores on 24th June '10 and it has marginally improved to the deficit of Rs.41,000 crores. Hence, there was no real need for any CRR hike in the current policy. However, RBI has confirmed that real policy rates are not consistent with growth rates and hence going forward Repo Rates would be the operating policy rate, indicating a tightening bias.

Inflation is expected to come down in future due to its base effect and the expected improvement in agricultural production leading to softening of agri prices. However, considering the current realities RBI has increased its inflation target from 5.5% to 6%.

10 Year G-sec yields have marginally inched up to 7.70% however they are expected to remained capped in the range of 7.70% to 7.80% levels in the near term.

The Current deposit growth is around 15% where as the credit growth has moved up to 21.7%. Even if we consider a part of this credit as short term in nature, there would be a pressure on deposit rates. With increased rates, the cost of deposits of banks would move up and this would lead to an increase in Base Rates in due course.

Considering the rapidly evolving macroeconomic situations and to avoid uncertainty & speculation, the RBI has decided to undertake mid-quarter reviews. This means that most of the policy action would now be either at the time of announcement of quarterly policy or at the time of mid quarter reviews.

Source : Equity Bulls

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