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3QFY2013 Monetary Policy Review

RBI reduces repo by 25bp, CRR by 25 bp
Policy Measures 
„The Reserve Bank of India (RBI) in its Third Quarter Monetary Policy Review for FY2013 reduced the repo rate by 25bp from 8.0% to 7.75%.„ Consequently, the reverse repo rate stands adjusted at 6.75% and the marginal standing facility (MSF) rate and bank rate stand adjusted at 8.75%.„ The Cash Reserve Ratio (CRR) too has been reduced by 25bp from 4.25% to 4.0% of banks’ net demand and time liabilities (NDTL) since liquidity remains tight and due to persistence of the wedge between credit and deposit growth. 
„The CRR reduction is expected to inject around `18,000cr of primary liquidity in the banking system.  
Policy stance more supportive of growth… 
The RBI has further scaled down its growth forecast for FY2013 to 5.5% from 5.8% in its October policy review. Growth is likely to remain subdued for the fiscal year on the back of slowdown in private consumption,  investment and exports. In light of the slowdown in growth and moderation in inflation, the RBI’s policy stance is increasingly shifting towards supporting growth. At the same time, we believe that the RBI still remains cautious in its approach on account of any negative surprise emanating from inflation and the twin deficits, ie current account deficit and fiscal deficit.  
…But reiterates persistence of inflation risks in FY2014 
The recent trend of moderation in inflation is positive for the interest-rate environment in the economy. Headline WPI inflation moderated for the third month to 7.2% in December 2012. Core (manufactured non-food) inflation too edged to a two-year low of 4.2%, well within the RBI’s comfort level. The RBI has scaled its inflation forecast for FY2013 downwards to 6.8% from 7.5% in its October policy review. Going ahead in FY2014, the RBI expects inflation to remain range-bound at the current level. Earlier during the month the government partially deregulated diesel prices by allowing oil companies to hike retail prices gradually while allowing full price adjustment for bulk consumers. We believe that this move strengthens the government’s efforts towards fiscal consolidation but release of suppressed inflation is likely to lend an upward bias to inflation going ahead. In that context, we believe that favorable movement in international crude oil prices and INR are pertinent for further moderation in inflation.
Policy Outlook 
We believe that the RBI has adopted a balanced approach weighing the growth-inflation dynamics in its policy stance and it marks a material shift from its earlier rigidly hawkish policy stance. Going ahead we believe that the monetary policy stance is likely to be determined by the shaping up of the twin deficits and food inflation. As far as food inflation is concerned although it remains at worryingly high double-digit level, we believe that its trajectory is likely to improve as rabi sowing has progressed well so far and the hike announced by the government in Minimum Support Price (MSP) for rabi crops particularly wheat at 5% is moderate (as compared to generous MSP hikes for kharif crops). Moreover, core inflation at 4.2% is already within RBI’s comfort level. Additionally, the recent policy moves towards fiscal adjustment such as the hike in diesel prices, thrust on divestment drive and indications of a fiscally prudent budget are also steps in the right direction and are likely to give the central bank more headroom to ease policy rates. However, the current account deficit at  5.4% of GDP in 2QFY2013 is alarming and presently this in our view is the key factor limiting headroom for the RBI to cut rates more aggressively. This is because aggressive rate easing could stoke demand for imports further and a weak currency would also lead to higher imported inflation. Secondly, attracting capital flows is key to financing the current account deficit and lower interest rates could discourage capital flows particularly debt inflows to finance the CAD. Therefore, we maintain our view on reduction in repo rate by about 100 bp in 2013.Source: Angel Broking

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