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RBI Rate Cuts

March 20, 2013

RBI cuts the key policy rate - Repo rate by 25 bps to 7.50%. Accordingly the Reverse Repo and Marginal Standing Facility (MSF) rate
stands reduced to 6.5% and 8.5% respectively.
RBI keeps the CRR rates unchanged at 4.00%, even while maintaining that the current liquidity deficit is above the comfort zone. However, states that it will use other instruments like Open Market Operations (OMO) to infuse adequate liquidity.
RBI raises concern on increasing wedge between the Wholesale Price Index (WPI) inflation and Consumer Price Index (CPI) inflation,
which has adverse implication for inflation expectations.
Though the policy stance emphasizes on addressing growth risk, it states that headroom for further monetary easing remains limited, in
view of inflationary pressure and high current account deficit.
RBI reduced the policy repo rates in its mid-quarter monetary policy by 25 bps, broadly in line with market expectation.
However, RBI states that the headroom for further cuts is limited. RBI states that the stubbornly high CPI inflation and high current account deficit are the major hurdles for aggressive monetary easing.
While maintaining that the reviving growth is the key macro-economic priority, RBI states that low interest rates is not the only enabler to revive growth and sufficiency conditions includes bridging the supply constrains, staying the course on fiscal consolidation and improving governance.

IMPACT ON BOND MARKET:

The initial reaction of the bond market to RBI’s policy review has been negative, with 10 year benchmark yield moving up by 2-3 bps post the
announcement. The adverse reaction has been mainly on account of the accompanying statement, which is perceived to be hawkish.
As the policy states that room for further monetary easing is limited, we do not expect any significant upside in sovereign bonds from current levels, though the expected OMO buy-back in the coming days, may lend some support to bond yields at current levels. We expect the 10 year benchmark yield to trade in a broad range of 7.75%-7.95% going forward.

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