Credit Policy: RBI maintains status quo

The RBI maintained status quo on the policies declared in its quarterly review earlier today. Economic growth has been in line with its expectations, and hence keeping in view the upside risk to inflation it has reiterated status quo stance. It has stressed on the fact that policy actions could be taken to mitigate inflation risks going forward as and when required. The central bank also shifted its focus from credit quality to credit delivery and hence pointed out to banks to improve their
delivery infrastructure. Although the policy stance has not changed much, we feel that interest rates have peaked out, and from here on banks need to decide on their mode of action by determining the changes in deposit and lending rates to make the most out of the busy season demand ahead.

Highlights of Q3FY08 monetary policy

  • Bank rate, reverse repo rate, repo rate and CRR remains unchanged
  • GDP growth projection for 2007-08 maintained at 8.5%
  • Inflation target at around 5% for FY08
  • Money supply growth continues to remain above target as aggregate deposits of scheduled commercial banks continue to expand, while non- food credit decelerated
  • Liquidity management will be given priority in the conduct of monetary policy through appropriate and timely action

Monetary policy stance The central bank’s position remains similar in comparison to the last couple of quarters, albeit with some moderation. We say some moderation because of RBI Governor Y.V Reddy’s statement – “developments in the domestic economy are broadly in line with policy expectations, and in the normal course would not warrant any significant monetary policy initiatives at this juncture.” Price stability, proper credit delivery to deserving sectors and global events remain the central bank’s main concerns. It intends to adopt required measures to deal with the events as and when required.

Impact on markets, mostly factored in The market had earlier factored in a 25bps cut in rates; but post the policy announcement, barring some readjustment in the equity markets, other markets remained stable implying that the readjustment had happened prior to the policy outcome.

Equity The market fell sharply after the news of a status quo policy. Spot Nifty fell from 5302 to 5226 within a minute of the announcement. However, the impact was short lived and the market again stabilised to reach earlier levels.

Bond Ten-year bond yield moved up by only 2 basis point.

Currency The rupee dollar rate also remained relatively unchanged at INR 39.39=1USD.

Inflation – upside risks remain The RBI has stated that indications of an upside inflationary risks are getting stronger due higher crude prices. It also feels that the upside risks to inflation remain from higher commodity and food prices, hence inflation may perk up without an upward revision in fuel prices.

Hierarchy of capital flows It feels, in the context of a more open capital account and the size of inflows currently, a hierarchy of capital flows with priority for more stable components would be a welcome policy change. Combining sectoral regulations with broader measures to enhance the quality of flows and make the source of flows more transparent. Thus we feel more differentiation on the type of capital flows could be on the cards.

Enhancing credit delivery to sectors that are employmentintensive RBI also shifted its focus from credit quality to credit delivery and hence pointed out to banks to improve their delivery infrastructure. This is something that RBI has suggested to banks, and doesn’t come as a directive hence its impact may remain neutral.

Impact on banks We feel an unchanged position on rates signals a peaking of our interest rate cycle, hence banks are likely to review their deposit and lending rates and we expect some realignment to happen so that banks are able to capitalise on the busy season ahead without diluting their margins further. We continue to remain positive on the banking sector.

Conclusion We feel the policy is in line with our status quo expectations. However, the RBI has not hinted at any rate cuts, while global events, domestic inflation and capital flows are likely to be the key factors to be monitored going forward.

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