The 25bps hike in repo and reverse repo rate by the RBI is a reinforcement of its anti inflationary stance. The market reconciled itself to a rate hike post the August inflation numbers of 9.78% and its reaction to the rate hike is just a shrugging of the shoulders. Equity markets are higher by close to 1% while bond yields are marginally higher by around 2bps post the rate hike. The INR is slightly higher by Rs 0.10 at around Rs 47.47 levels to the USD. The market will look at a period of policy rates stabilising at levels of 8.25% on the repo rate and 7.25% on the reverse repo rate with liquidity in the negative zone.
Going forward the market direction will be determined by global issues more than domestic issues. On the domestic side, inflation is expected to stay at close to 9.5% levels for the next couple of months before trending down. There is a downside risk to RBI GDP growth forecast of 8% as acknowledged by the central bank. Credit growth at 20.1% year on year as of August 2011 is above RBI’s target of 18%, and this credit growth is driven primarily by oil marketing companies (OMC) paying for losses sustained due to fuel sold at subsidized prices. OMC borrowing has increased by 24% from end of March 2011 to end have August 2011 and stands at Rs 120,000 crores. Outlook for credit growth is not positive given high lending rates (lending rates to corporate and retail borrowers have moved up by 250bps to 400bps over the last one year due to RBI rate hikes and tight liquidity conditions). RBI has acknowledged a slowdown in investments due to interest rates, inflation and other structural problems.
The global risk aversion issue is more important to the markets at present. The movements in the Indian Rupee (INR), Indian equities and Indian government bonds have been dictated by global trends since the last policy review on the 26th of July 2011, where the RBI raised policy rates by 50bps. The INR has tanked by almost 9% from levels of Rs 44.10 to levels of Rs 48 (levels at which RBI had to intervene) on the back of volatility in global markets. Indian benchmark equity indices the Sensex and Nifty have fallen by over 8% while government bond yields are down by 10bps with the ten year benchmark bond yields coming off from 8.45% to 8.35%. Continued volatility in global markets on worries of debt default by Greece, recession in Europe and growth slowdown in the US will keep domestic markets pressured.
The RBI has adopted a more easy tone on inflation in this policy review. RBI expects inflation to come off in the first and second quarter of calendar year 2011 on the back of lagged effects of policy transmission. The central bank has recognised serious risks to global growth and its consequent effects on India. The markets will start to factor in status quo on policy rates in the forth-coming policy reviews.