Comments on RBI Mid Quarter Monetary Policy Review - Mr. Rajrishi Singhal, Head policy and research - Dhanlaxmi Bank

RBI Finally Relents, Interest Rate Cycle to Reverse: The Reserve Bank of India (RBI) announced its mid quarter monetary policy on Friday, December 16. As expected, RBI left interest rates unchanged but admitted rather candidly that the interest rate cycle is likely to reverse in the future given the downside risks to growth. The monetary tightening cycle — which spanned over 22 months with 13 rate hikes so far — has hit economic growth hard. Though RBI has stressed that inflation and inflationary expectations continue to remain elevated, it expressed hope that inflation would decline due to moderating growth and declining food prices. While RBI sounded cautious on inflation, it explicitly admitted that the monetary policy cycle is likely to reverse its course to address concerns regarding risks to growth. It took the following decisions at its December mid quarter review of the 2011-12 monetary policy:

- Repo rate unchanged at 8.50%
- Consequently, reverse repo rate unchanged at 7.50%, as it has been pegged 100 bps below repo rate
- Marginal Standing Facility (MSF), instituted 100 bps above repo rate, unchanged at 9.50%
- CRR and SLR were left unchanged, as expected

RBI's pause in rate action follows its second quarter monetary policy guidance where it had hinted that rate action in December is unlikely. RBI's monetary policy today is also a reflection of the sharply decelerating economic growth momentum, as well as the overwhelming presence of downside risks to growth. As concerns about slowing domestic economy are increasingly be-ing felt, RBI has indicated a reversal from its tightening monetary policy maintained so far, subject to inflation easing and sta-ble macro-economic conditions.

Reversal in Monetary Cycle: RBI highlighted that as global and domestic economic conditions have deteriorated further from its last monetary policy review in October. As inflation is likely to moderate, despite rupee depreciation, it has maintained its 7% inflation target for March. With sharp decline in investments and industrial activity, it is also necessary to look at the growth dynamics. RBI said "monetary policy actions are likely to reverse the cycle, responding to the risks to growth".

Growth Dynamics Finally Take Centre stage: RBI admitted a sharp moderation in economic activity, as seen by the contraction in IIP and corporate investments. It pointed out that moderation is due to the impact of past monetary policy actions and weakening global demand. RBI is likely to revise of its GDP growth target of 7.6% for FY12 in January 2012.

PRU View: RBI's policy document clearly reflects a shift in focus — from inflation combat to growth promotion. As ex-pected, RBI has started weighing the weakening global economic scenario along with the weakening demand pressures in the domestic economy and has, therefore, supplied a guidance for reversal of policy rates. We feel this is a good sign as the eco-nomic slowdown is broad-based. Both the Q2 GDP growth number (at 6.9%) and the 5.1% contraction in October IIP seem to have served as a wake-up call. The slowdown in the corporate investments pipeline and deteriorating business confidence can jeopardise GDP growth in FY13 and therefore RBI's change of policy stance augurs well for the economy. We feel that this could be the beginning of an easing cycle, subject to inflation behaving in the weeks ahead.

GDP Growth For FY12 Likely To Get Downgraded From 7.6% YoY: RBI's admission of moderating growth is notewor-thy. Slowing investments and worsening business climate can derail growth prospects for coming years as investments have long gestation periods. It pointed out that agriculture prospects are promising due to a record kharif output and satis-factory progress in sowing of the rabi crop. In light of the visible moderation in economic growth, RBI is likely to revise in January 2012 the GDP growth target of 7.6% for FY12 provided in its second quarter review.

Inflation On A Downward Trajectory: RBI has pointed out that though overall inflation was still high but is moderating due to decline in primary articles inflation. It should ease going ahead due to moderation in demand and commodity prices leveling off. WPI inflation in November came down to 9.1% YoY compared with 9.7% YoY in October. The central bank felt that moderation in demand was more evident on investments side. It maintained that despite higher commodity prices and depreciation of the rupee, inflation is expected to decline due to slowing growth. Rupee has depreciated by ~17% since Au-gust 2011.

RBI retained its inflation target of 7% by March 2012 while offering the reassurance that "headline momentum indicators, such as the seasonally adjusted month-on-month and 3-month moving average rolling quarterly inflation rate, show continuing signs of moderation".

Fiscal Situation Has Worsened: Fiscal performance has worsened with slowing economic growth. In April-October, reve-nue receipts growth decelerated sharply from a year ago, mainly because of shortfall in tax and non-tax revenues. Fiscal defi-cit in April-October stood at 74% of 2011-12 (April-March) budget estimate, far higher from 43% of budget estimate in the same period last year. Present macroeconomic environment leaves little scope for improvement in revenue receipts. The slip-page in fiscal deficit has inflationary implications.

Credit Growth Decline Anticipated: Non-food credit growth at 17.5% YoY as on December 5, 2011, is lower from RBI's indicative projection of 18% for FY12. Credit growth will slow down going ahead due to moderation in eco-nomic activity.

Money Supply: M3 growth stood higher at 16.3% YoY in December, compared with RBI's projection of 15.5% for FY12. This is likely to come down going ahead. Money supply growth though has come down from 17.3% YoY in the beginning of the financial year.

A slowdown in money supply and credit growth rates are pointers that the impact of past rate hikes is now taking hold.

Liquidity Conditions Worsened Liquidity conditions have remained consistent with the RBI's anti-inflationary stance of monetary policy as liquidity has been in deficit mode so far in 2011-12. However, liquidity deficit worsened signifi-cantly from second week of November 2011. Average daily injection of liquidity through LAF has been around Rs.84,000 crore in November-December period so far compared with Rs.49,000 crore in April-October 2011. RBI's stand on liquidity remains unchanged: they will maintain deficit liquidity in line with their monetary stance, but without ham-pering flow of funds to productive sectors of economy. Thus, RBI conducted three Open Market Operations (OMO) totalling Rs.24,000 crore to help reduce the liquidity deficit. It also stated that further OMOs will be conducted "as and when seen to be appropriate." In the weeks ahead, RBI could ease CRR to help ease liquidity and improve business confidence, provided inflation stays on the downward trajectory.

Source : Equity Bulls

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