January 28, 2014

Update on the Third Quarter Review of Monetary Policy 2013-14
This is a brief update on the Third Quarter Review of Monetary Policy 2013-14.

by Dr Renu Pothen

Update Monetary Policy 2013-14

Update on the Third Quarter Review of Monetary Policy 2013-14

Raghuram Rajan seems to have a good time in surprising the markets whenever there is a monetary policy review. This is a trait that we have observed since he became the boss at the Reserve Bank in September 2013. Whenever the market participants expect him to tighten monetary policy, he goes into a silent mode and when the market expects him to be in a pause mode, he tightens the policy rates. Well, academicians are known to be unpredictable and Rajan is proving that he is in no way an exception.

In the Third Quarter Monetary Policy Review-2013-14, the Governor has gone ahead and hiked the repo rate and made it very clear in the document that “The extent and direction of further policy steps will be data dependent, though if the disinflationary process evolves according to this baseline projection, further policy tightening in the near term is not anticipated at this juncture”. This is a signal to the market not to waste time to predict if Rajan is going to hike rates or not. Instead investors should take exposure into debt instruments which are not too sensitive to interest rate movements.

In the Mid-Quarter Monetary Policy Review held in December 2013, the Governor’s statement read like this: “The policy decision is a close one. Current inflation is too high. However, given the wide bands of uncertainty surrounding the short term path of inflation from its high current levels, and given the weak state of the economy, the inadvisability of overly reactive policy action, as well as the long lags with which monetary policy works, there is merit in waiting for more data to reduce uncertainty. The Reserve Bank will be vigilant. Even though the Reserve Bank maintains status quo today, it can help guide market expectations through a clearer description of its policy reaction function: if the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the next round of data releases, or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted, so that inflation expectations stabilize and an environment conducive to sustainable growth takes hold”.

In the Third Quarter Monetary Policy Review held today, the RBI’s statement reads like this: “While retail inflation measured by the consumer price index (CPI) declined significantly on account of the anticipated disinflation in vegetable and fruit prices, it remains elevated at close to double digits. Moreover, inflation excluding food and fuel has also been high, especially in respect of services, indicative of wage pressures and other second round effects. In terms of the wholesale price index (WPI), headline inflation eased to a four-month low with the sharp decline in vegetable and fruit prices. Non-food manufactured products (NFMP) inflation, however, rose in December on an uptick in prices of chemicals, non-metallic minerals and paper products. Hardening prices of services and key intermediates seen in conjunction with rising bank credit, increase in order books, pick-up in capacity utilisation and the decline in inventories of raw materials and finished goods in relation to sales suggests that aggregate demand pressures are still imparting an upside to overall inflation. It is critical to address these risks to the inflation outlook resolutely in order to stabilise and anchor inflation expectations, even while recognising the economy is weak and substantial fiscal tightening is likely in Q4”.

It’s only been a month since Rajan spoke about overly reactive policy action and the need to wait for more data before taking an action and then he goes and hikes the policy rates in the next month.

Our advice to investors is not to get stressed due to the uncertainty that is emanating from Mint Street. Take exposure into short term funds for a one-year time horizon and dynamic bond funds, if the holding period is more than a year. As we have been informing our investors in our previous notes that though the market is moving towards duration funds, we are  on a wait and watch mode before we recommend the same to our investors.

Dr. Renu Pothen
Research Head-Investment Advisory Division

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