RBI made the December 2012 policy review a non event and guided markets for monetary easing starting January 2013. Equity, bond and currency markets will start factoring easing system liquidity and lower repo rates in 2013 leading to rallies in Sensex, Nifty, ten year bond yields and the INR going forward. Investors should position their investments to take advantage of the focus shift of the RBI from containing inflation expectations to supporting growth.
RBI chose to keep the CRR (Cash Reserve Ratio) unchanged at 4.25% despite tight system liquidity. Liquidity as measured by the bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI stood at a negative Rs 146,000 crores on the 17th of December 2012 on the back of advance tax outflows moving out of the system. RBI kept CRR unchanged as it was buying government bonds through OMOs (Open Market Operations). RBI has bought bonds worth Rs 23,245 crores through bond purchases auctions held in December. RBI is expected to announce more OMO purchase auctions to infuse liquidity into the system.
The rising incremental credit deposit ratio (ICDR) is one of the factors that is making RBI focus on liquidity. ICDR has gone up from levels of 20% seen a few months back to levels of 76% fiscal year to data. Deposit growth at 12.80% year on year as of 30th November 2012 is lagging credit growth at 17% year on year leading to banks being forced to draw down on liquidity to fund credit growth. A rising ICDR above 76% levels will exacerbate liquidity tightness.
RBI with its changed focus on growth will want to make liquidity comfortable for banks. In order to keep liquidity comfortable the central bank will have to buy more bonds and will have to cut the CRR further from levels of 4.25%. RBI government bond purchases will help bond yields come off as excess supply in the market is absorbed by the central bank leading to traders pushing down yields to build positions for repo rate cuts starting January 2013.
RBI chose to keep to its October policy guidance of monetary easing in January 2013. RBI forecasts that inflation will be at higher levels for the next two months before easing off. The lower than expected inflation reading for November 2012 did not make the RBI move away from its October policy guidance. Inflation as measured by the WPI (Wholesale Price Index) came in at 7.24% against market expectations of 7.6% and against October levels of 7.45%.
The central bank is sticking to its growth forecast of 5.8% for full year 2012-13 despite the average growth of 5.4% achieved in the first half of the fiscal. The economy has to grow by 6.2% for the second half of fiscal to achieve RBI’s growth target of 5.8%. Higher economic growth requires monetary easing by the central bank and the RBI has guided markets for easing going into 2013.
The market reaction to RBI’s lack of auction indicates that markets will look at the future. Ten year government bond yields traded almost flat post policy announcement with the benchmark 8.15% 2022 bond trading at levels of 8.15%. The Sensex and Nifty went into negative territory post the announcement but are trading marginally positive after bouncing back from lows. The Indian Rupee (INR) followed equities by giving up pre policy gains to trade flat post policy. Markets have a lot to look forward to in 2013 with growth expected to pick up, inflation expected to ease and RBI cutting rates. Stay positive on the markets.