RBI's Monetary Policy Review

The Reserve Bank of India in its recent monetary policy review has announced a rate cut by 25 basis points. The benchmark interest rate has been reduced from 7.75% to current 7.5%. A similar move that was seen in January by RBI was seen this time too, when the bank made the rate cut announcement. Previously the central bank of India reduced the rate from 8% to 7.75%, a cut by 25 basis points. Over the past one year the apex bank has reduced rate by 1 percentage on a cumulative basis.

What prompted the Move

The growth of the economy has taken a toll from all time highs of over 9% (a year ago) to 4.5% (half the growth which prevailed in good times). Inflation measured by WPI or the Wholesale Price Index has fallen below 7% from 8% in September. We thus see a lower growth coupled with lower inflation, which resulted in a rate cut by the RBI.

For RBI though the move was not easy as we see the retail inflation measured by CPI or the Consumer Price Index is sticky and remains at an all time high of 11%. A sharp increase in the food prices over the past 1 year has resulted in rising food inflation. Also the rise in Minimum Support Prices (MSP) by the government has resulted in typical rise in food products at the retail level. Due to a change in MSP by 10-15% every year, a rise in food prices have been seen for the past years which has been a cause of significant pressure on upward retail price inflation.

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Thus we see that combined with a lower trend in WPI and growth, room for policy rate reduction is minimal though with the CPI being sticky at a level, RBI after reduction of policy rates said further room for reduction of policy rates is limited. RBI pointed out the biggest problem of the economy- the current account deficit. We as a developing nation, currently import far more than the exports which is creating a pressure on the performance of the economy, mainly the currency (directly) and monetary policy (indirectly).

While on the front of high consumer inflation and current account deficit, it is said that further modification in monetary policy is likely to happen when the government takes proper action on the two burning problems of the nation. Thus it is now required that the government works towards the reduction of MSPs aimed at controlling inflation. The move will help RBI to reduce interest rate further, helping the Corporates.

Expectation of the Market

The quarter cut in the interest rate was highly anticipated. The 10 year benchmark yield of government bonds has improved by 3 basis points only to close at 7.9%. The supply of new government securities followed by the trajectory of interest rates will help to drive the yield of the bonds in future.

Outlook

It is expected that the RBI will further announce a rate cut in coming months, thus it is advised to add duration to the portfolio of the investors. A medium reduction in the duration was however seen recently due to the large run up in the government securities. As a matter of fact, it is expected that the market will see certain positive movements in the coming years and the year 2013 is expected to be regarded as the year of equities. The addition of duration in portfolio will help the investor see the investment grow eventually.

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