September 29, 2015
Dr.Rajan seems to be getting better each day in surprising the market participants. In the Fourth Bi-Monthly Monetary Policy review 2015-16 held today, the Governor cut the repo rate by 50 basis points to 6.75%. The CRR remained unchanged at 4% of the net demand and time liability (NDTL). Although a rate cut was expected, a 50 basis points reduction in repo rate came as a pleasant surprise and this has resulted in celebration on Dalal Street.
In the previous monetary policy review held in August, Dr. Rajan stated that ”Significant uncertainty will be resolved in the coming months, including the likely persistence of recent inflationary pressures, the full monsoon outturn, as well as possible Federal Reserve actions. As the Reserve Bank awaits greater transmission of its front-loaded past actions, it will monitor developments for emerging room for more accommodation.”
The Governor’s reason for today’s decision to ease the monetary policy stance can be gauged from the statements outlined below.
“Since our last review, the bulk of our conditions for further accommodation have been met. The January 2016 target of 6 per cent inflation is likely to be achieved. In the monetary policy statement of April 2015, the Reserve Bank said that it would strive to reach the mid-point of the inflation band by the end of fiscal 2017-18. Therefore, the focus should now shift to bringing inflation to around 5 per cent by the end of fiscal 2016-17. In this context, the weakening of global activity since our last review suggests that commodity prices will remain contained for a while. Still-low industrial capacity utilisation indicates more domestic demand is needed to substitute for weakening global demand in order that the domestic investment cycle picks up. The coming Pay Commission Report could add substantial fiscal stimulus to domestic demand, but the government has reaffirmed its desire to respect its fiscal targets and improve the quality of its spending. Under these circumstances, monetary policy has to be accommodative to the extent possible, given its inflation goals, while recognizing that continuing policy implementation, structural reforms and corporate actions leading to higher productivity will be the primary impetus for sustainable growth. Furthermore, investment is likely to respond more strongly if there is more certainty about the extent of monetary stimulus in the pipeline, even if transmission is slow. Therefore, the Reserve Bank has front-loaded policy action by a reduction in the policy rate by 50 basis points”.
In our outlook on the fixed income market for the month of September, we had stated that “There is a strong pressure on the Reserve Bank Governor to reduce rates in the forthcoming review meeting to be held on Sept 29, 2015. We believe that easing of the monetary policy would happen only after taking into consideration, factors like how the transmission of rate cuts have taken place, inflation, monsoon and the outcome of the US FED Meet on Sept 17, 2015”.
In the current policy review, the Governor has made it clear that he has front loaded the rates like he did in June when he cut the rates by 25 bps. We are of the view that the governor will go into a silent mode for a few months before taking any action on the monetary policy front. We continue to suggest dynamic bond funds to our moderately aggressive and aggressive investors. However, a note of caution to our existing investors in the long term debt funds is not to exit from their current holdings on account of today’s rate cut. Our stance is based on the fact that there is more scope for the RBI to get into a monetary policy easing mode as inflation is already under control, while the economy’s growth momentum seems to be a concern for the policy makers.
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