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Monetary policy review

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Mr.Dhananjay Sinha

Head of Research and strategist.

08 Feb 2017

Monetary policy review: RBI is signaling the end of the rate easing cycle

The decision of RBI to keep policy rates unchanged belies consensus expectation, but is unsurprising for us. Importantly, the central bank has shifted its stance on monetary policy to neutral from accommodative.

Factors driving this change in view includes both global and domestic are:

a)      Global factors:

   i.Bottoming out of global inflation on the back of rising commodity prices and mild firming up of demand conditions

   ii.Tightening of global financial conditions led by normalization of monetary policy in advance economies, led by the US Fed

   iii.Protectionism policies adopted across the world which contributes to inflationary pressures

   iv.Expectation of fiscal stimulus in the US, strong infrastructure spending in China, supply cuts and receding recessionary trends Russia, China & Brazil

b)      Domestic factors

     i.Rebound in inflation is expected from upswing in prices of perishable food items like vegetables, amid sticky core inflation hovering around ~5%

     ii.Expectation of narrowing of output gap induced by improvement in demand conditions

     iii.Policy focus to revive demand particularly from increase in rural, affordable housing budget allocation and ease in retail lending rates

     iv. Fuller effects of HRA under 7th Central Pay Commission (CPC) still to pan out

     v. Spill overall effects of hardening global commodity prices on core inflation

     vi. Pass-through from stronger USD due to US Fed rate normalization and fiscal expansion on India’s inflation trajectory


RBI is signaling the end of the rate easing cycle

The change in Monetary Policy stance is also accompanied by RBI’s admission that there is still some scope of transmission of its earlier policy rate cuts on market determined interest rates (MCLR, Deposit rates etc). Such additional transmission would require active government policy interventions like a) betterment of NPA situation of banks, b) recapitalization of banks and c) adoption of market determined rates for small saving schemes.


The overall stance of RBI has been outlined as the improvement in demand conditions ebbing from higher inflation. Accordingly, as real GVA growth recovers from 6.9% in FY17 to 7.4% in FY18, base case inflation would also rise from current 3.5% to 5% by end of FY18. As the near term impact of demonetization fades out both demand and inflation are likely to rebound in the near term.



To sum up, the above assessment of RBI is broadly in line with our position that global factors would weigh heavily on interest rate outlook, even as we recognized the beneficial impact of a prudent Union Budget FY18 (Emkay’s Union Budget Review: Receding fiscal support prognosticated on private demand revival, Feb 1, 2017). Hence, we now believe that the rate easing cycle has almost ended. Absence of further rate easing and lack of active OMO purchases will aid hardening in Gsec yields; at 6.7% 10 year Gsec yields has hardened 25bp after the policy announcement. We expect further steepening in Gsec curve with 10 year yield hardening to over 7%. The above view is also in tandem with our Gsec yield model of rising Gsec yield from improvement in bank credit demand, tightening global financial conditions and hardening US yields.


From markets standpoint consensus trades based on expected further rate easing (eg. Pro PSU banks etc) will reverse due to status quo policy decision and change in stance. The outlook of better demand and higher inflation is generally positive for growth oriented sectors which in our view would emanate from rural including consumers, affordable housing, roads and private lenders.


Link to RBI’s policy statement-Click here