RBI changes policy stance, maintains key interest rates

The RBI today, announced its monetary policy updates, which were pretty much in line with our expectations. All the key rates remained unchanged. The Repo and Reverse Repo Rates were retained at 8.50% and 7.50% respectively. Cash Reserve Ratio (CRR), which was in the news as many analysts and economists expected a cut, was also left unmoved at 6%. The Statutory Liquidity Ratio (SLR) was also at the same level, i.e. 24%.

On the global front, the RBI said that the Euro zone has still not come up with an acceptable solution with regard to their sovereign debt crisis. The recent Euro Summit did not give a clear picture about solving the crisis, which is likely to create further financial turbulence and recession in Europe. Growth in the emerging market economies is affected by the growth in the developed economies, and is also witnessing an impact of the past monetary tightening.

On the domestic front, the margins of companies moderated in Q2 FY12. This was on the back of higher input costs and the rising interest burden, and has further resulted in the decline of pricing power of the companies. Inflation though, has shown some signs of cooling. On a MoM basis, the headline WPI inflation came down by 60 bps to 9.1% in Nov 2011. On the other hand, the RBI stated that industrial activity is showing signs of a slowdown and has seen declining investment, which results in a serious slowdown. This is evident from the fact that the IIP numbers for Oct 2011 came in at a negative 5.1% on a YoY basis.

In its report, the RBI also stated that there is no significant stress in the money market. However, banks are borrowing higher under the Liquidity Adjustment Facility (LAF), above the RBI’s comfort level. Open Markets Operations (OMOs) will be conducted by RBI as and when it deems appropriate.

The central bank has guided that inflation will remain at the projected levels, but the downside risk to growth has increased substantially. For the first half of FY12, the GDP growth came in at 7.3% versus 8.6% for the similar period last year.

The RBI also said that from here on, its monetary policy action is likely to reverse if there is more risk of growth going down. The 3rd quarter review of the monetary policy for 2011-12 is scheduled on Jan 24, 2011. We, at DSIJ, believe that the RBI has taken the right step in maintaining a dovish stance. With food inflation coming down and dismal IIP numbers, we feel that the regulator may take steps to cut the rates going forward, so as to fuel growth on the back of abating inflation.