RBI policy: Extended pause with hawkish undertone: Kotak

The RBI maintained status quo on policy rates but the communication remained hawkish with adequate risk factors being highlighted for inflation. With the RBI indicating that it will look beyond the transitory dip in inflation on account of base effects, the RBI has set itself up for an extended pause. We believe that in the medium term, the probability of policy tightening is higher than policy loosening. The cost of funding for the banking sector will likely increase marginally with shift in liquidity injection through term repos away from the LAF.

Interest rates unlikely to soften soon

Even as the RBI kept the interest rates unchanged, we believe there is little chance for any rally in the bond markets in the short term.

-The RBI maintained its hawkish policy communication and also primed the market not to expect any easing of monetary policy even as headline inflation comes off due to base effects.

-The RBI will now allow FIIs to invest only in G-Secs with residual maturity of one year and above and not in T-bills. FIIs had recently shown interest to mainly invest in the T-bill segment in an atmosphere of election-related uncertainties. Thus, this move can reduce FIIs investments in G-Secs.

-Chances of OMOs are reduced with the RBI moving further into the term-repo structure. We maintain our view that 10-year G-Sec is likely to hover in the 8.60-8.90% band in FY2015.

RBI maintains a hawkish undertone

The RBI kept the policy rates unchanged, largely premised on the fact that the disinflationary process has evolved better than expectations but the surprise factors for inflation could be (1) weather uncertainties and El Nino effects, (2) extent of MSP increases and pricing of other administered items, (3) the fiscal stance and (4) geopolitical risks to global commodities. Further, the RBI reduced hopes of monetary policy easing due to softer headline inflation by indicating that it will gloss over transitory effects and maintain the glide path to 6% by January 2016 (after 8% by January 2015). In the same vein, any food-led increase in inflation will also be critically evaluated to understand the transient versus longstanding implication of this on overall inflation.

Liquidity management via term repo to increase short-term cost of funding at the margin

In line with the Patel Committee's recommendations, the RBI has reduced access to overnight LAF to 0.25% of bank-wise NDTL, while compensating with a commensurate increase in term repos to 0.75% of system NDTL. While this is likely to lead to a better transmission of monetary policy changes, it pushes the onus of liquidity management more towards the banking sector. As the banking sector will have even limited access of funds (~'200 bn drop in the liquidity access via the LAF window) at the fixed repo rate, risks to fluctuations of the overnight money market rate within the LAF-MSF corridor are likely to increase, leading to a higher cost of funds for the banking sector.

Monetary policy to be on a pause in FY2015, but chances of hikes remain

The RBI reiterated if inflation continues along the intended glide path, further policy tightening in the near term is not anticipated at this juncture. As a base case, we think that the RBI will likely remain on an extended pause but with a higher probability of moving higher in the event of inflation failing to behave as per expectations. If growth cheers emerge under a new government, this could exacerbate inflation expectations, as the negative output gap is closing down. Risks of weather-related shocks in primary articles inflation can also not be ruled out immediately.

Powered by Capital Market - Live News