Will RBI retain easy monetary policy?

The Reserve Bank of India today released its review of the macroeconomic and monetary developments which serves as a background to the Second Quarter review of Monetary Policy 2009-10 being announced tomorrow, October 27th, 2009.

reserve bank of india

Some of the Key Highlights of the documents which we believe will set the tone of the monetary policy are:

Global economy has started exhibiting tentative signs of recovery, but the recovery is, however, widely perceived to remain slow and gradual, with receding but significant downside risks

  • The first quarter GDP growth in 2009-10 still points to persistence of slowdown
  • Information available on various lead indicators in the second quarter of 2009-10 suggests that because of deficient monsoon, kharif output may be adversely affected
  • Deceleration in aggregate demand that was witnessed in the second half of 2008-09 continued during 2009-10. Growth in private consumption demand fell to as low as 1.6 per cent in the first quarter of 2009-10. Investment demand also decelerated further, and the high growth in government consumption demand that was witnessed in the last two quarters of 2008-09 moderated.
  • Deficient monsoon and the associated drought like conditions in several parts of the country, and the more recent floods in some other parts, could also dampen rural demand
  • External demand continues to be weak. Trade data show that during April-August 2009, merchandise exports and imports declined by 31.0 per cent and 33.4 per cent, respectively, over the corresponding period of the previous yea
  • The liquidity conditions remained in surplus on a sustained basis, which was absorbed by the Reserve Bank through reverse repo operations under the Liquidity Adjustment Facility (LAF) and the over night rates hovered around LAF signaling ample liquidity into the system
  • The changing inflation environment, however, is being driven by strong escalation in prices of food articles, which have increased by 14.4 per cent (year-on-year) so far. Excluding food items, the WPI inflation remains negative at (-) 3.4 per cent.
  • From the stand point of monetary policy, anchoring inflation expectations in the face of sustained high inflation in essential commodities will be a key challenge
  • The Reserve Bank’s professional forecasters survey points to downward revision to the growth outlook from 6.5 per cent to 6.0 per cent in 2009-10.
  • Emerging inflationary pressures may also persist and escalate further on account of the fading away of the base effect, cost push pressures through wage-price revisions in the face of elevated CPI inflation, challenges in improving the supply situation of essential commodities in the short-run, gradual pressure on global commodity prices along with global recovery, and rising inflation expectations on account of elevated CPI inflation.
  • The overall economic outlook is, therefore, a mixture of upside prospects of recovery and downside risks. Managing the trade-off between supporting growth and reining in inflation expectations poses a complex policy challenge.

Summary:

The tradeoff will be costly since the capital markets are moving way beyond the real economy. However, we do not expect a rate hike in the second quarter monetary policy review due to a bleak growth outlook, however the tone in which inflation is presented in this press release by the RBI clearly sets a prelude for a rate hike in the third quarter policy review or even before that.

The way Nifty has behaved over the last 4 trading sessions clearly suggests that markets are factoring in a change in RBI’s stance. Thus we strongly believe that its time in the market to start booking profits and move away from the rate sensitive like banking, infrastructure and real estate.

Author: Rahul Sonthalia, Analyst, Kredent Group

Related posts:

  1. RBI likely to raise rates in todays monetary policy review
  2. Monetary Policy and Credit Policy
  3. RBI Monetary Policy 2010
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