RBI Hold Rates, Rupee A Worry

As expected by most, the RBI has kept key policy rates unchanged. As per the policy statement, the repo rate and cash reserve ratio (CRR) have been kept unchanged at 7.25% and 4% respectively. The minor possibility of a rate cut is now extinguished thus giving scope to some crack in the markets and rate sensitive stocks.

The RBI, in its statement, has said that from the last policy meeting in May, the global economic activity has slowed with higher risks. “On the domestic front, macroeconomic conditions remain weak, hamstrung by infrastructure bottlenecks, supply constraints, lackluster domestic demand and subdued investment sentiment”, reads the RBI report. On the inflation front, the RBI has said that inflation has moderated as projected. However, upside pressures due to rupee depreciation, recent increases in administered prices and persisting imbalances, especially relating to food, pose risks.

It means that the recent weakness in the rupee, hikes in petrol and diesel prices and higher food prices can be risky to the current level of inflation. The May 2013 WPI number had come in at 4.7% against 4.89% in April 2013. The March 2013 number was also revised downwards to 5.65% from the provisional 5.96%. Food article inflation, however, remained at elevated levels, thus posing a risk to inflation. The forecast of a normal monsoon may act as a saviour in easing food prices. Although the May CPI numbers were eased, they were below market expectations. Food inflation numbers remained at higher levels there too.

The worrying factor from the markets’ point of view is the industrial growth in April 2013 which came in below expectations. With the global weakness, the likelihood of a slowdown in FY14 will remain a big threat to the economy. Nevertheless, the lower rates are yet to be transmitted by the banks and this may lead to lower demand in the economy. Corporates having higher debt may have to wait for some more time to get the benefit of the earlier rate cuts.

The RBI's commentary was focused on external factors such as the rupee which tanked to its lowest level in June 2013. It has said that the trade deficit has widened due to a surge in gold imports. The apex bank has said that the moderation in gold imports is currently underway. It has also said that the external financing requirement has moderated in June 2013.

On the outlook front, food inflation remains a key talking point for the RBI. The outlook on inflation will be determined by revisions in administered prices as well as the course of the INR. Appreciating the lower CAD number at 4.9%, it has further said that the sustainable lower level of CAD would help in mitigating the twin deficit risks.

The monetary policy stance will be determined by how growth, inflation trajectories and the balance of payments situation evolve in the months ahead, said the RBI. This implies that the RBI's policy would now be dependent mostly on macro factors.