The Reserve Bank of India left repo and consequently reverse repo rate unchanged at 7.75% and 6.75% respectively. It also left CRR unchanged at 4.0%. This comes at a time when participants were debating over a 25bps or 50bps hike after steep rise in wholesale and retail inflation.
Every governor has been peculiar in decision making and Mr. Rajan is no different. After an extreme uptick in WPI and CPI, primarily on the back of food articles, market more or less priced in a hike of at least 25bps with a tad hawkish stance.
Food article inflation which has been a structural issue is hovering in double digits since 11th five year plan. Last dozen of data shows this is continuing in the next five year plan as well. Rajan from start is pretty clear over its objective to tame inflation and inflation expectation.
RBI’s decision of status quo is drawn from steady core inflation. They believe food and vegetable prices will soon come off bringing down the headline wholesale and retail inflation substantially.
RBI said that at a time when uncertainty surrounding short term path of inflation is high, and given the weak state of economy there is merit in waiting for more data to reduce uncertainty.
More importantly RBI said it will be vigilant and check if the expected softening of food inflation does not materialize and translate into a significant reduction in headline inflation in the next round of data releases failing to which the Reserve Bank will act, including on off-policy dates if warranted.
RBI’s action pulled down yields considerably down by ~12bps from ~8.90% to ~8.78%. Aggressive buying was limited as rate hike risk still persists after RBI clearly stated to act on off-policy dates as well.
Short term CD/CP rates receded after RBI’s surprising move. 2M/1Y CD rates fell ~30/15bps. Banks and corporates aggressively jumped in the market to raise funds via CDs and CPs respectively. Frugal government is expected to keep liquidity tight for a prolonged period.
Coming Inflation and growth numbers will hold a key importance in RBI’s decision making process. Anecdotal data suggests that vegetable prices have receded by ~40-60% m-o-m in early December. This if continues can bring down next number considerably down compelling RBI to keep rates untouched.
Bond market has taken a hit from a number of domestic and global factors. OMOs, which mightily supported bonds in the second half, are almost absent. Fiscal worries as well are driving investors jittery to some extent, this is even after Chidambaram succeeded in limiting previous year’s deficit at announced level.
Traders will wait for an update from US over its quantitative easing programme using which it had added more than a trillion dollars in the financial system. Strong pullback in its buyback quantum will be negative for the economy however the impact is not expected to be severe on the bond side. Note that FIIs cumulatively has sold bonds worth ~835bn since 22nd may when Fed first hinted pulling back its stimulus.
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