Meeting Expectations
S Nagnath
Joint President & CIO, DSP Merrill Lynch MF
The credit policy announced today met market expectations. The bank rate and the cash reserve ratio were both reduced by 25 bps each. However, market expectations had been considerably lowered in recent days after the release of inflation statistics that showed wholesale price index-based inflation at 6.47 per cent for the week ended April 12.
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Although this number was high, it was attributed largely to the base effect and therefore expected to become moderate in the coming weeks. Nevertheless, a rising inflation index coupled with expectations of stronger economic growth ahead (6 per cent GDP growth expected in FY 2004) did not sit squarely with the prevailing expectations of a further significant decline in interest rates.
The benchmark 10-year gilt yield, after hovering around 5.85 per cent, has now edged up to 5.93 per cent.
Interestingly, the policy statement observes that there is not much scope for a significant decline in interest rates going forward. Certainly, a decline of the magnitude seen in 2001 and 2002 does not seem likely to be repeated.
Since the persistent downward trend in interest rates reflected a moderation of inflationary expectations and a comfortable liquidity situation, largely due to robust forex inflows, let me analyse these two variables further.
A good monsoon will keep food prices soft and, therefore, inflation benign. However, the demand for food credit is likely to rise and this could exert some pressure on liquidity.
A less than normal monsoon could cause food prices to rise and bump up inflation. Also of some importance is the slow rise in the price of manufactured products, reflecting perhaps a strengthening in pricing power for some sectors.
Oil prices have often been cited as the prime contributors of volatility to inflation statistics. I expect them to behave similarly in the next 6-12 months. Even though oil prices have declined after the end of the Iraq war, they could just as well begin to edge upward if there are substantial output cuts.