Mid-Quarter Monetary Policy Review

Transcription

1 18 December, 2013 Mid-Quarter Monetary Policy Review RBI maintained status quo in the mid-quarter monetary policy meeting held today preferring to wait and watch for more forthcoming macro-economic data before changing the stance. In the meeting, RBI left unchanged key policy rates namely repo unchanged at 7.75% and cash reserve ratio at 4% of net demand and time liability (NDTL). This move came as a positive surprise since market was expecting 25 bps hike in key policy rate. RBI Policy: repo and cash reserve ratio left untouched The policy repo rate under liquidity adjustment facility (LAF) remained unchanged at 7.75%. Cash reserve ratio left unchanged at 4% of NDTL. Economy Update Policy Stance and Rationale behind policy action Recent readings suggest that headline inflation, both retail and wholesale, have increased, mainly on account of food prices. While Consumer price index (CPI) and wholesale price index (WPI) inflation excluding food and fuel have been stable, despite a steady and necessary increase in administered prices towards market levels, the high level of CPI inflation excluding food and fuel leaves no room for complacency. However, RBI has preferred to wait for additional macro-economic data prints, before determining the course of monetary policy. There are indications that vegetable prices may be turning down sharply, although trading mark-ups could impede the full pass-through into retail inflation. In addition, the disinflationary impact of recent exchange rate stability should play out into prices. The negative output gap, including the recent observed slowdown in services growth, as well as the lagged effects of effective monetary tightening since July, should help contain inflation. Forward guidance: The current inflation levels are high both wholesale price inflation and consumer price inflation. Given the wide bands of uncertainty surrounding the short term path of inflation from its high current levels, and given the weak state of the economy, the inadvisability of overly reactive policy action, as well as the long lags with which monetary policy works, RBI has preferred to wait and watch for more macro-economic data. Bottomline: RBI s statement clearly indicates that although the inflation is on radar, it will watch forthcoming macro-economic data points as well as global developments like tapering of quantitative easing by US Fed for any further monetary actions. Thus Rate action seems to be postponed rather than eliminated. RBI has clearly indicated that if in next round of data releases, headline inflation, food prices or core inflation do not soften, RBI will act, including on off-policy dates if warranted. Going forward, RBI will be maintaining adequate liquidity. Currently, normal access to liquidity from RBI is to the tune of 1.5% of NDTL (to tune of about Rs. 1.2 trillion). Repo rate looks to peak at 8.0%, another 25 bps hike from here, in light of peaking WPI & CPI Inflation data.

2 Forecast of Macro indicators Macro Indicators Projection for FY14 as on July 30, 2013 Latest numbers Projection for FY14 as on Oct 29, 2013 GDP growth (% yoy) 5.5% 4.8% (2Q, FY14) 5.0% WPI Inflation (end Mar) 5.0% 7.52% (Nov, 2013) around 7%* CPI Inflation % (Nov, 2013) around 9% or above* Money Supply (M3) 13.0% 14.5% (29 th Nov, 2013) - Deposit growth 14.0% 16.1% (29 th Nov, 2013) - Non-Food Credit Growth 15.0% 14.2% (29 th Nov, 2013) - *Based on fan chart given in Policy report, CPI estimate given for the first time Assessment of the Domestic Economy Growth Pick-up in Indian economic growth in Q2 of at 4.8%, albeit modest, was driven largely by robust growth of agricultural activity, supported by an improvement in net exports. However, the weakness in industrial activity persisting into Q3, still lackluster lead indicators of services and subdued domestic consumption demand suggest continuing headwinds to growth. Tightening government spending in Q4 to meet budget projections will add to these headwinds. FY 14 GDP is likely to be below the 5% mark. Inflation CPI : Retail inflation measured by the consumer price index (CPI) has risen unrelentingly through the year so far and has remained stubbornly high. Core CPI ( CPI ex food & fuel ) remain high at 8.0%. We expect food inflation to correct from the current high levels on indications that vegetable prices in particular may be turning down sharply. Thus though the CPI seems to peak at 11.24% for November, it will be anchored around % by March 14. WPI : Wholesale inflation has also gone up sharply from Q2 onwards; with upside pressures evident across all constituent components majorly on account of the pass through of the administered fuel price hikes and due to the rupee depreciation impact.core WPI seems to be stable around 2.6%. With softening of food prices going ahead, we expect WPI to be around the 7% mark by March 14. RBI seems to have taken comfort from the Core CPI & WPI data but at the same time maintained caution against its sustainability. Current account deficit (CAD) The narrowing of the trade deficit since June through November, on positive export growth and contraction in both oil and non-oil imports, should bring the current account deficit (CAD) down to a more sustainable level for the year as a whole. Robust inflows into the swap windows ( 34 bln $ ) opened by the Reserve Bank during August-November have contributed significantly to rebuilding foreign exchange reserves thus covering possible external financing requirements and providing stability to the foreign exchange market. Looking ahead, these favorable developments should help to build resilience to external shocks. We expect FY 14 CAD to be around 46bln $, 2.5% of GDP. Liquidity Management With the normalization of exceptional monetary measures, liquidity conditions have improved, as reflected in the steady decline in the access to the MSF (Marginal Standing Facility). Capital inflows under the Reserve Bank s swap facilities for banking capital and non-resident deposits ( 34 bln $ ) augmented domestic liquidity significantly from the end of November. Anticipating the temporary tightness in liquidity starting from mid-december 2013 on account of advance tax payments, the Reserve Bank conducted additional 14-day term repo auction of `100 billion on December 13, augmenting the normal access to liquidity from the Reserve Bank to the tune of 1.5 per cent of NDTL (i.e., about Rs. 1.2 trillion) under overnight repos, term repos, and the export credit refinance facility.

3 RBI Rate Actions Our interpretation on today's policy; RBI adopted a wait and watch policy on account of intermediary spike in vegetable and fruit prices leading to higher inflations nos and the same is already correcting downwards. In light of weak economic data evident from the IIP and GDP nos, negative output gap and comfort from improving CAD RBI preferred to wait and judge the lag effect of past hikes rather than react immediately. Also, in light of uncertainty on the external front as far as impact of tapering goes RBI has made its stance clear that this is not a pause but a temporary halt to judge the evolving situation. If the inflation trajectory does not move on expected line RBI made its stance clear by its readiness of intermediary policy action if needed. Outlook going forward In light of evolving macro and political scenario and on account of recent policy actions by the RBI we feel there are both positives and negatives which can direct the markets in future; Positives to support in the medium to long term... RBI's policy has clearly based their further rate actions on the inflation movement in the coming months and as per our view both headline as well as core is expected to peak out due to declining vegetable and fruits. CAD nos are increasingly becoming comfortable with FY 14 CAD expected at below 3% of GDP much lower than expected at the beginning of the year. GDP is also expected to stay weak in the near future. On all the macro factors interest rates are increasingly becoming an attractive preposition in addition to its current absolute high levels. If Finance ministry goes ahead with inclusion of India Government Bonds in Global Bond Indices the medium term demand concerns will be taken care off. Baring the near term views the evolving macro scenario and current levels certainly makes a case for long term investment horizon as in addition to the higher carry yield, the interest rates over a period of time might start correcting downwards as clarity emerges on the political front and growth might have to be supported by better liquidity and lower rates in the economy.

4 Though all the above parameters are hinting at yields to correct downwards over medium term the current demand supply situation and higher level of absolute inflation level will keep yields in check in the near term... From Now till beginning of February we have INR One Trillion of GOI secs supply and further supply of approx INR crores of State Development Loans (SDL) till March In the current scenario where domestic institution have slightly lower appetite in light of slower deposit growth and FII's also reluctant to buy at the current exchange rate and given the uncertainty due to tapering and inflation level, meeting this kind of supply in absence of Open Market Operation (OMO) buybacks by RBI looks difficult. Also, bond swap under which GOI plans to buyback there near maturity Gsecs ( next 3 years ) and issues 15 year maturity g-secs may also add to supply at the year segments keeping the yield range bound till the end of the year. Post January 2014 markets would take cues from the developing political scenario and also borrowing numbers for FY 15 which are expected in the range of 6.50 to 7.00 trillion on a gross basis which might also limit any major fall in yields from current levels. Portfolio positioning The long bond portfolios are running moderate to long Gsecs allocations spread across the curve some part of extreme long end allocations have been shifted to short and belly of the curve in light of very narrow spreads available on the extreme long end of the Gsec curve. The corporate bond allocations are mainly into the 1-5 year part of the curve considering improving liquidity conditions and attractive carry available. The short bond portfolios are running low duration with allocations mainly into the 1-3 year part of the curve with no Gsec allocation currently. In light of the above facts we expect a range bound movements on GOI secs for the rest of FY 14 and any extreme moves both positive as well as negative would be determined by evolving situations on the Global bond index inclusion front, liquidity conditions due to portfolio flows into the country and political front. Source: RBI,CMIE & Bloomberg Disclaimers The views expressed herein constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. This information is meant for general reading purposes only and is not meant to serve as a professional guide for the readers. Certain factual and statistical (both historical and projected) industry and market data and other information was obtained by RCAM from independent, third-party sources that it deems to be reliable, some of which have been cited above. However, RCAM has not independently verified any of such data or other information, or the reasonableness of the assumptions upon which such data and other information was based, and there can be no assurance as to the accuracy of such data and other information. Further, many of the statements and assertions contained in these materials reflect the belief of RCAM, which belief may be based in whole or in part on such data and other information. The Sponsor, the Investment Manager, the Trustee or any of their respective directors, employees, affiliates or representatives do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and opinions given are fair and reasonable. This information is not intended to be an offer or solicitation for the purchase or sale of any financial product or instrument. Recipients of this information should rely on information/data arising out of their own investigations. Readers are advised to seek

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