The Reserve Bank of India (RBI) on Tuesday increased the key policy rates by 25 basis points (bps) each, as the central bank steps up its efforts to tackle a stubbornly high inflation at the cost of some moderation in economic growth.
The repurchase rate (repo rate) has been hiked by 25 bps to 6.50%, while the reverse repo rate has also been increased by 25 bps to 5.50%. The central bank also extended the 1% leeway in the SLR up to April 8. CRR has been left unchanged at 6%.
The inflation target for FY11 has been increased to 7% from 5.5% earlier while the GDP forecast for the current fiscal year has been kept steady at 8.5% with an upward bias.
The RBI had raised key policy rates six times last year as the Indian economy accelerated, sending inflation sharply higher. But several factors, including unseasonal rains and spike in global commodity prices has kept inflation elevated.
Dr. D. Subbarao, Governor of the RBI had decided to take a pause in its last meeting on December 16 amid a severe shortage of cash in the banking system and some softening in food inflation.
Inflation shot up to 8.43% in December, from 7.48% in the previous month, the Government said on January 14. October's inflation rate was revised to 9.12% as against the provisional estimate of 8.58%.
Inflation in the Food Articles group fell to 15.52% in the week ended January 8 from 16.91% in the week ended January 1, the Commerce & Industry said on January 20.
The RBI said today that the new actions are expected to:
Contain the spill-over from rise in food and fuel prices to generalised inflation.
Rein in rising inflationary expectations, which may be aggravated by the structural and transitory nature of food price increases.
Be moderate enough not to disrupt growth.
Continue to provide comfort to banks in their liquidity management operations.
The next mid-quarter review of the Monetary Policy for FY 2010-11 will be announced through a press release on March 17, the RBI said today. The Monetary Policy for FY 2011-12 will be announced on Tuesday, May 3
Commenting on RBIs policy, Ramesh Rachuri, Senior Fund Manager - Fixed Income, Bharti AXA Investment Managers said, "In the January policy, the Reserve Bank of India hiked the Repo Rate to 6.50%, and the Reverse Repo Rate at 5.50%. It also continued with some of its liquidity infusing measures by continuing with the reduction in Bank’s SLR by 1%, for their LAF (Liquidity Adjustment Facility). RBI has also stated that the expected outcome from this action is to – “contain spillover from rise in food and fuel prices; rein in rising inflationary expectations; be moderate enough not to disrupt growth; and provide banks comfort in their liquidity management operations.” The Reserve Bank also hiked the baseline projection of WPI inflation for March 2011 to 7.00%.
Clearly, the stance of the RBI has been consistent with the issues flagged off in the assessment – credit growth, current account deficit, and inflation. Essentially, RBI has stated that the effectiveness of monetary policy is muted in the presence of a large fiscal deficit. Therefore, all eyes would be on the coming budget in February, wherein the fiscal picture would get clearer. If the fiscal situation does not get better in also tackling inflationary/demand side pressures, the RBI is expected to hike rates further in the meeting on March 17th. In essence, the slow and gradual approach in monetary management continues in the hope of maintaining growth.
Next, we have to look at the liquidity situation. The current liquidity deficit scenario (deliberately maintained by RBI in its stance of fighting inflation), partly due to the government parking of surplus with RBI, has also arisen on account of the increasing credit off take, and increase in money in circulation. It is believed that increase in currency in circulation is also on account of negative real interest rates (for some, it is just not attractive to hold money in the bank, versus using it in the cash economy). Going forward, till March, given the negative real interest rates, the latter two factors enumerated above will gain in importance. Although the SLR relaxation has been continued for banks till April 8th, banks would likely continue ploughing into credit. This is expected to keep liquidity tight till March end, after which, with the new budget, government spending would likely bring the quantum of illiquidity down.
In light of the above, and given the expected uncertainty, especially on the global commodities side, we would continue to gradually build up on duration and credit, till the end of March, keeping in mind frictional liquidity fund flows. Also, we would build more on the short term money market instruments like CDs (Certificates of Deposit), and CPs (Commercial Paper) which are offering attractive yields, and would give adequate liquidity going into the new financial year in our Bharti AXA Liquid Fund, and Bharti AXA Treasury Advantage Fund. In the Bharti AXA Short Term Income Fund, we would periodically continue to increase duration from policy to policy, as we expect between a 25bps - 75 bps hike throughout this financial year, and then peaking out, unless inflation/forex levels go through the roof. This would enable us to exploit the high carry of the higher duration securities. Further, an active tactical trading and management of short tenor bonds would substantially enhance returns over a one to three month period, in the Bharti AXA Short Term Income Fund.