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Any rate hike in future may disturb liquidity easing measures

Even as the RBI expects food inflation to come down, it expects retail inflation to remain at around 9% in the coming months, FundsIndia.com says

October 30, 2013 9:24 IST | India Infoline News Service
The RBI (Reserve Bank of India) in its Second-Quarter Review of Monetary Policy 2013-14 today hiked the repo rate by 25 bps (basis points) to 7.75%. The central bank kept the CRR (cash reserve ratio) unchanged at 4%. 

The repo rate is the rate at which banks borrow from RBI and one basis point is equivalent to 0.01%. 

RBI Governor Raghuram Rajan, in his second policy review, has cut MSF (marginal standing facility) rate to 25 bps to 8.75%. MSF rate is an overnight borrowing rate for banks, which eases the cost of funds for lenders, fuelling credit growth.

The central bank expects GDP at 5% in FY13-14 and CPI to remain at or above 9%.

Commenting on RBI policy, Vidya Bala, Head-Mutual Funds Research, FundsIndia.com, said: The MSF rate cut and measures to ease liquidity will further ease rates in the short-end of the yield curve. As acknowledged by RBI, between mid-September and October, money market rates fell by 125 basis points. The latest cut together with liquidity easing measures would mean a price rally in short-term debt instruments for some more time.

Debt funds with short-term maturity have rallied over 1% on an average between the last monetary policy and now and saw gains as much as 1.7% in a span of a month.
While 10-year gilts fell 6 basis points to 8.58% soon after the policy was announced, this may be seen more as a relief rally. Going forward, with rate decisions hinging mainly on retail inflation, any rally in long-term gilt prices may be unlikely. It would be prudent for investors to avoid any fresh exposure to long-term gilt funds at this juncture.

Even as the RBI expects food inflation to come down, it expects retail inflation to remain at around 9% in the coming months, absent policy action.

While this statement suggests a hawkish stance, it may also be noted that any rate hike in the coming calendar may disturb the liquidity easing measures done so far. It may also affect the higher fund demand that typically arises in the last quarter of a fiscal. As a result, such a hike could also mute the 5% GDP growth that the RBI expects for FY-14. Viewed from this angle, a near-term rate hike would require strong economic triggers.



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