RBI’s Monetary Policy Review

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CONTENTS

Policy Overview

Q3 Current Rates

Impact on market

FII & DII Activity

Factors Pushing rates Up

Is It Enough?

Future Outlook

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Policy Overview
Policy Measures

The central bank has hiked the repo rate (rate at which banks borrow from the RBI) by
25 bps to 6.5% and the reverse repo rate (rate at which the RBI borrows money from
banks) by 25 bps as well to each to 5.5%. It has kept the cash reserve ratio, or the
CRR unchanged at 6%. The RBI has also extended liquidity support to scheduled
commercial banks under the liquidity adjustment facility to up to 1% of their net demand
and time liabilities or NDTL, which was set to expire on January 28 till April 8. The
second LAF has been extended up to April 8.

Inflation Forecast
The central bank has revised its forecast on the Wholesale Price Index inflation for
March 2011 to 7% from 5.5% it had projected in its second quarter review. Inflationary
pressures, though subdued in advanced economies, have intensified in emerging
market economies due to sharp increases in food, energy and commodity prices, the
RBI said. While it expects inflation to moderate in the first quarter of the next fiscal in
India, it sees inflation becoming a global concern in 2011.

GDP Growth Forecast

The RBI has retained its baseline projection of GDP growth for FY11 at 8.5% as set out
in its second quarter review of monetary Policy of July 2010, but with an upside bias.
The central bank however cautions that India's GDP may decline in the next fiscal.
Current account deficit is projected to be around 3.5% of GDP this fiscal.

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Q3 Current rates
Reserve Ratios Value (In %)
CRR 6.00
SLR 24.00

Policy Rates Value (In %)

Bank Rate 6.00
Repo Rate 6.50
Reverse Repo Rate 5.50

Impact on Market
On 25 Jan 2011 before the policy announcement, around 11:35 a.m. the Nifty and
Sensex were almost 1% up. The Nifty was around its day’s high of 5800 and the
Sensex was around 19340 but after the announcement of the result the Indian equity
market slipped down and closed almost 1% down. The Nifty closed at 5687 and Sensex
at 1896. The market reacted positively initially as this 25 BPS was already factored in by
the market but market tumbled down as Investors expected another round of rate hike
in march considering the fact that this action was not proactive enough.

The impact of the policy was not stopped was continued for next few days also and the
market breached the crucial 200 DMA (a strong support level), breaking its 5610 level
and slipped more than. 1.5% on next day and crossed the Nifty’s sentimental levels of
5500 on the second day and tested 5460 level on Friday. The overall fall was more than
5.50% in both Nifty and Sensex after the credit policy announcement till 28 Jan.

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FII & DII Activities (in crore)

On 24th Jan (Before the policy announcement)

Category Date Buy value Sell value Net value

FII 24-Jan-11 2558.12 2494.17 63.95

DII 24-Jan-11 1474.93 1238.42 236.51

After the policy announcement

Category Period Buy value Sell value Net value

FII 1/24/2011 to 1/28/2011 10811.7 12896.96 -2631.24

DII 1/24/2011 to 1/28/2011 4228.39 4572.42 -344.03

The FII’s have pulled out more than 2600 Cr from the market post credit policy as this
rate hike is going to gradually affect the earnings of the companies in the coming
quarter pressurizing their net profit margins. This rate hike of RBI is seen as a
temporary measure to curb the inflation while it is overall inefficient in controlling the
inflation and investors expect another round of rate hike in coming quarters.

Factors pushing rates up

Economic growth has accelerated and this has created its own upward pressures.
Some producers are discovering their pricing power. Global commodity prices,
especially petroleum, have been rising. Recently retail petrol prices were raised yet
again. The government is holding on to the diesel prices, which, unlike petrol prices, are
yet to be decontrolled.

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Either way, inflation or inflation expectations are set to rise. Surely, the subsidy bill will
go up. Non-food manufactured goods inflation now at around 5.3 per cent is bound to
go up as the high global commodity prices get reflected in domestic prices. The
government's rural initiatives and social sector spending have boosted aggregate
demand. There is a growing demand for protein products, milk, eggs and meat. Prices
of these have gone up and are behind the surge in food inflation. In contrast cereal
prices, wheat, rice and pulses have not risen.

Is it enough?
Large primary liquidity injected by the Reserve Bank to ease the liquidity pressures
without diluting its anti-inflationary focus. Deficit liquidity conditions helped in
strengthening the transmission of policy rate actions to deposit and lending rates.
The RBI’s focus was on balancing growth and inflation in the past, now that focus is
shifting towards inflation. The RBI’s monetary policy focus is on trying to ensure that
food and energy prices do not percolate down into generalized inflation. Fiscal
consolidation with the government at this point looking alright but that is largely on
account of certain one off benefits that the government has got by way of the spectrum
auctions and disinvestment proceeds but saying clearly that that is not the way to go
forward for the government.

The government needs to do its part in addressing fiscal issues that with a high fiscal
deficit, the task of monetary policy and addressing inflation becomes that much more
difficult. Again flagging of the issue of subsidies that are being extended by the
government which it says at some level delays the process of transmitting real prices
down to the economy, effectively creating artificial demand at the end simply by
lowering prices and absorbing that cost onto its books.

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The current account deficit at the 3.5% levels is unsustainable, also pointing to the fact
that if until now capital inflows into India have some way helps address the current
account deficit. Going forward that may not be the case; it may not be sustainable
simply because of revival in overseas economies. There is the risk of capital, especially
FII inflows, leaving the country and creating a bit of a challenge for the country. The
need for foreign capital flows to be more driven by foreign direct investments done by
FII inflows.

Future outlook
The RBI says prospects of global growth have improved in recent weeks. It said that
while growth in advanced economies may improve, growth in emerging market
economies may moderate due to monetary policy tightening to tame inflationary
concerns and the fading impact of fiscal stimulus measures taken during the global
financial crisis. The RBI expects food, commodity prices and crude prices to harden in
2011, driven primarily by supply constraints and rising global demand as advanced
economies consolidate their recovery, indicating that inflation may become a global
concern in 2011. With advanced economies showing firmer signs of sustainable
recovery, global growth in 2010 is expected to have been less imbalanced than before.
While growth in advanced economies may improve, growth in EMEs, which have been
the main engine of global economic growth in the recent period, may moderate due to
tightening of monetary policy to address rising inflationary concerns and the waning
impact of the fiscal stimulus measures taken in the wake of the global financial crisis.

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