Expect more of the same thing

Prudential Measures

 To a market that was expecting specific rate actions from the Governor to signal further downward movement of interest rates, the credit policy was a dampener.

 Now where do markets go from here? Clearly, the inflationary situation, robust domestic growth and signs of recovery in global economy have influenced the governor in keeping the rates steady.

 However, inflation is expected to come down in the next few months as the base effect of last year wears off and agricultural growth softens food prices.

 But it is the interest rate differential between Indian and global economies, particularly at the short end, that exerts significant downward pressure on Indian rates.

 Higher interest rates in India compared with global rates spur flow of foreign money into India to exploit the differential.

 What can the markets expect? Expect more of the same thing that we have seen in the past, because everything needs to give in a little. Rupee would appreciate some more.

 Interest rates would fall some more. Forex reserves would rise some more. Intervention and sterilisation strategy would continue, so would restrictions on capital inflows.

 The RBI has been moderating these variables through a careful balance of allowing play of market forces and intervention. Expect that to continue.

 When would this cycle come to an end? When expectations in domestic and global markets change and the interest rate differential between Indian and global markets narrows.