We Expect Short Term Rates To Move Down In Line With the Repo Rate<
17-Apr-12   20:00 Hrs IST

Mr. Santosh Kamath
1) What are your views on RBIs annual monetary policy (FY13)?

The quantum of rate cuts took the market by surprise given the cloudy outlook on inflation and recent RBI views that growth moderation has been modest. The recent weak economic data along with soft headline inflation numbers (especially manufacturing goods inflation) may have prompted RBI to cut rates in order to prevent any sharp slowdown in growth. Instead of any further CRR cuts, the central bank opted for an increase in the borrowings cap under the Marginal Standing Facility (MSF).

At the same time, the central bank maintained a very cautious stance about future rate actions and highlighted concerns on various fronts - inflation and twin deficits. RBI expects inflation to remain at current levels as the recent high global commodity and energy prices impact input costs and domestic fuel prices, offsetting any benefits from moderation in demand side pressures.

The various measures announced as part of its efforts to reduce systemic risks are positive, given the sharp rise in gold related lending activities. Other policy measures such as reducing variance on retail/bulk deposits could lead to higher costs for banks and increased volatility in the last quarter of every fiscal year. After adjusting the bank rate earlier this year, RBI has adjusted the bank rate to 9%, bringing it in line with the MSF rate and this should be the trend going forward. Overall, the policy statement reflects the tough choices faced by the central bank and it has chosen to protect growth at the risk of inflation. It also appears to have chosen a higher rate cut, given the lag in monetary transmission.


The aggressive rate cuts led to a fall in g-sec yields across maturities - however the extent of downshift was relatively less steep in the 5-year segment, as compared to the 10-year gilt yields.

Equity markets rallied helped by the rate cut along with positive trends in European markets. Stocks in some interest rate sensitive sectors moved higher, especially infrastructure and real estate. The latter was boosted by hopes of increased demand due to lower rates and also removal of the pre-payment penalty on floating rate loans. Banking sector did not move up substantially as RBI's tone was not dovish and some of the policy measures such as lending to gold-related NBFCs, minimum variance on deposits and waiver of pre-payment penalty on housing loans, were seen to have a negative impact on margins.

2) What are your views on the increase in global commodity and energy prices? What will be their impact on the global economy?

The increase in global commodity and energy prices has led to concerns about the impact on the global economy. After holding on to higher interest rates, many central banks in EM countries have started to ease their monetary policies, with countries like Brazil following up with a large fiscal stimulus package. With growth trends in key developed markets such as US showing a positive sign, demand pressures could push up global prices. However, resolution of geo-political issues can help alleviate some of the pressures on the energy front. With key central banks supporting further quantitative easing, the search for higher yields could continue.

RBI has ensured that it does not release any animal spirits by the aggressive rate cut through its qualifying comments and cautious tone regarding the future. It has clearly indicated that the probability of further rate cuts over the near term is low, until unless the economic data flows provide comfort. Now the focus shifts to trends in inflation as well as the twin deficits. Given the moderation in economic growth, there remain concerns about government's borrowings and the fiscal deficit that can contribute to inflation. On the other hand, a transparent and conducive policy environment can help in attracting further capital flows, and reducing the pressure on current account. We expect short term rates to move down in line with the repo rate, but continue to be cautious about the long end of the curve due to the various reasons mentioned above.

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