Monetary policy review - 29oct13
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On October 29, 2013, the Reserve Bank of India (RBI) increased the repo rate by 25 basis points to 7.75% while lowering the MSF rate to 8.75%, adjusting the interest rate corridor to 100 bps. The RBI has also revised its growth estimate for FY14 to 5% and increased its inflation forecast to 5.5%, noting that WPI inflation is expected to remain elevated. The document suggests volatility in the shorter end of the yield curve and advises risk-averse investors to consider ultra short-term funds while exploring dynamic bond investments for longer horizons.
Monetary policy review - 29oct13
- 2. Announcements RBI Policy Announcements – • Repo rate increased by 25 bps from 7.5% to 7.75% • MSF rate cut by 25 bps from 9% to 8.75% • Accordingly, rate corridor narrowed to 100 bps These announcements were as per consensus expectations. Other policy announcements were - • Interest Rate Futures on 10 Year G-Sec introduced • An increase in liquidity from 0.25% to 0.5% of NDTL under the Repo Window • RBI lowered its FY14 growth estimate to 5% from 5.5% held earlier. It also increased the end-March 2014 inflation estimate to 5.5% from 5% at present • RBI has also introduced estimates for CPI for the first time, reiterating its rising focus on CPI as a key policy benchmark • Unlike the past credit policies, RBI has done away with explicit forward-looking guidance on upcoming policies 2
- 3. Implications – 1/2 • The Reserve Bank of India (RBI) has now completed the process of re-aligning the interest rate corridor, bringing the MSF (Marginal Standing Facility) rate and the repo rate within the 100 bps spread. This has been done considering INR has been steady for last couple of weeks. • Measures to ease liquidity will allow commercial banks to borrow majority of their requirement at the repo rate instead of the MSF rate. This will allow for swifter transmission towards repo becoming the effective policy rate and the borrowing under MSF is likely to come off as RBI is increasing the liquidity availability. The recourse to funding under MSF may gradually reduce. This should allow short term rates to gradually ease assuming no significant additional currency withdrawals from the banking system in the coming months. 3
- 4. Implications – 2/2 • The central bank now expects WPI inflation to remain above the current levels (6.5 per cent in September) in the coming months, raising its inflation forecast for the entire fiscal above the earlier projection of 5.5 per cent. Hence, further repo rate hike (25 bps) in this fiscal to tame inflation can not be ruled out. • We expect longer end of G-Sec yields to remain range-bound with periodic bouts of volatility driven by incremental supply-demand dynamics. While the hawkish stance will limit the downside, positives could come in the form of possibility of inclusion of Indian G-Sec in global bond indices, expected OMO announcement, softening of food prices leading to moderation in CPI and operational overnight rate shifting back to the repo rate. From now till next monetary policy announcement, the yield curve is likely to steepen further driven by fall in yields, at the shorter end. • We expect the RBI to remove the borrowing limits through the LAF window. This would then make the repo the effective policy rate, which is likely to reduce the overnight borrowing rate to 8% (closer to repo rate, assuming further hike of 25 bps). 4
- 5. Suggestions • Shorter end of yield curve may soften till next monetary policy as Repo rate becomes more effective. However, as in next monetary policy, there is a possibility of hike in repo rate (considering elevated levels of inflation), the shorter end of yield curve may start facing volatility. Longer end of yield curve may remain more or less stable considering the expected announcement of OMOs by RBI. • Under such circumstances, tactically – for risk-averse investors it makes sense to gradually move closer to Ultra ST Funds and short tenured FMPs (preferable monthly interval plans). for investors who are willing to have relatively longer investment horizon (more than 12 months) and who are ready to see interim volatility, can invest some portion (say, 15-20%) of portfolio in Dynamic Bond Funds / Income Funds. P.S. – • The next Mid-Quarter Review of Monetary Policy for 2013-14 will be announced on Wednesday, December 18, 2013. The Third Quarter Review of Monetary Policy for 2013-14 is scheduled on Tuesday, January 28, 2014 5
- 6. 6 Jignesh Shah Capital Advisors 308 Vimal Society, Banganga, Walkeshwar, Mumbai 400 006. India. + 91 - 9820296989 jshah@capitaladvisors.co.in Contact Details
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