The Reserve Bank of India (RBI) made today’s mid-quarter policy review a non-event and guided for a monetary easing starting January 2013.
Equity, bond and currency markets will start factoring in easing systemic liquidity and lower repo rates in 2013 leading to rallies in the Sensex, Nifty, 10-year bond yields and rupee going forward. Investors should position their investments to take advantage of the focus shift of the RBI from containing inflation expectations to supporting growth.
The RBI chose to keep banks’ cash reserve ratio (CRR) unchanged at 4.25 percent despite tight system liquidity. Liquidity as measured by the bids for repo in the daily liquidity adjustment facility (LAF) auction of the RBI stood at a negative Rs 146,000 crores on the 17 of December 2012 on the back of advance tax outflows from the system.
The RBI kept CRR unchanged as it was buying government bonds through open market operations (OMOs). RBI has bought bonds worth Rs 23,245 crores through such operations in December. It is expected to announce more OMOs to infuse liquidity into the system.
The rising incremental credit deposit ratio (ICDR) is one of the factors that is prompting the RBI to focus on liquidity.
ICDR has gone up from levels of 20 percent seen a few months back to levels of 76 percent fiscal year to date. Deposit growth at 12.80 percent on year as of 30 November is lagging credit growth of 17 percent on year, forcing banks to draw down on liquidity to fund credit growth. A rising ICDR above 76 percent levels will exacerbate liquidity tightness.
RBI with its changed focus on growth will want to make liquidity comfortable for banks. In order to keep liquidity comfortable, the central bank will have to buy more bonds and will have to cut the CRR further from levels of 4.25 percent. The RBI’s government bond purchases will help bond yields come off as excess supply in the market is absorbed, leading to traders pushing down yields to build positions for repo rate cuts starting January 2013.
The RBI chose to keep to its October policy guidance of monetary easing in January 2013. It sees inflation at higher levels for the next two months before easing. The lower-than-expected inflation reading for November did not make the RBI move away from its October policy guidance. Inflation as measured by the wholesale price index (WPI) came in at 7.24 percent against market expectations of 7.6 percent and against October levels of 7.45 percent.
The central bank is sticking to its growth forecast of 5.8 percent for full year 2012-13 despite the average growth of 5.4 percent achieved in the first half of the fiscal. The economy has to grow 6.2 percent for the second half of fiscal to achieve the RBI’s growth target of 5.8 percent.
Higher economic growth requires monetary easing by the central bank and as per the guidance, it should happen in 2013.
The markets’ reaction to the RBI’s lack of action indicates that dealers are looking for action in the future. Ten-year government bond yields traded almost flat post policy announcement with the benchmark 8.15 percent 2022 bond trading at levels of 8.15 percent.
The Sensex and Nifty went into the negative territory post the announcement but are marginally positive after bouncing back from lows. The rupee followed equities by giving up pre policy gains to trade flat post policy. The markets have a lot to look forward to in 2013 with growth expected to pick up, inflation expected to ease and the RBI cutting rates. Stay positive on the markets.
Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.