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3rd Quarter Review of Monetary Policy - A Move Towards Normalization

January 29th, 2010

By Vikram Kotak, Chief Investment Officer, Birla Sun Life Insurance

RBI has yet again taken a calibrated move towards supporting economic growth without compromising price stability. CRR hike by 75bp (effective in two tranches) reflects RBI’s active liquidity management.

Given that average Rs.70000 cr is getting parked at LAF window daily, even after the withdrawal of Rs.36000 cr through this hike, there is still adequate liquidity in the system currently.
RBI has left repo and reverse repo rate untouched. In our opinion, RBI will not hike these rates unless a broad-based economic recovery takes place. Credit off-take still remains weak due to which RBI has reduced credit growth expectations for FY10 to 16% (from 18%). Further, given the fiscal deficit expectation for FY11, it seems that RBI would most likely wait for the government borrowing program for FY11 to be announced before sending a rate hike signal which could send bond yields northwards.
RBI has displayed optimism on economic growth by raising baseline FY10 GDP growth forecast to 7.5% (from 6%), However, it sees risk emanating from higher food prices which might transmit into a generalized increase in inflation. It has raised its FY10-end inflation estimate to 8.5% (from 6.5%).

We expect inflation concern to abate post July 2010 if monsoons are normal. We were positively surprised by RBI leaving risk weightages of sectors like real estate untouched.

Overall, while being concerned on inflation, RBI has rightly maintained a pro-growth focus. With the removal of half of the excess liquidity, we expect short-term rates to harden from the current levels.

We also expect this move to mark an end of the war on retail mortgage rates. Going forward, we expect RBI to hike Repo and Reverse Repo rates (50-75 bps in FY11), which we view as a move towards normalization. However, such hikes would be gradual and in a phased manner, in order to ensure sustained economic recovery.

Disclaimer:

The comments made above are informed views rather than firm predictions. BSLI recommend that these general views should be cross-verified and reaffirmed before being used for personal financial planning purpose. Neither Birla Sun Life Insurance Company Limited, nor any person connected with it, accepts any liability arising from the use of this document. The recipients of this material should rely on their own investigations.

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