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(NDTLs). These changes are unlikely to reduce the call rate substantially below the marginal standing facility (MSF) rate (currently 10.25%); but we believe they would offer some comfort to the markets, with the hope of further easing later.
We expect the Raghuram Rajan to sound a hawkish note on inflation. August CPI inflation remained elevated and the spike in WPI inflation to 6.1% raised concern about the future inflation trajectory. While the August WPI price pressures arose mostly from a temporary spike in vegetable prices, which we expect to wane in the next few months, the headline number is likely to keep the RBI cautious. Pass-through of higher import costs is not yet complete, and a one-off diesel price increase is still expected. We maintain that the pricing power of industrial products is extremely low – as evidenced in the 2% core inflation print – but Governor Raghuram Rajan is unlikely to focus on this. Markets will also be looking for an indication of his preferred gauge of inflation. They may respond negatively if the RBI’s concerns about high CPI inflation lead to expectations that CPI inflation will become the new nominal anchor.
In Raghuram Rajan's statement on 4 September, he highlighted containing inflationary pressures as a priority. This is in line with his long-held view of a monetary policy framework focused on a single objective, namely price stability or low and stable inflation. Raghuram Rajan has previously stated that there is no short-term trade-off between growth and inflation, and that low inflation also helps to stabilise the exchange rate without too much central bank intervention. Against such a backdrop, it will be difficult for the governor to strike a dovish note or turn more growth-focused. Raghuram Rajan has also highlighted fiscal discipline as a cornerstone of containing inflationary pressures and improving the conducting of monetary policy. The RBI may adopt a wait-and-see stance given that the government has yet to announce measures to contain the fiscal deficit at 4.8% of GDP – in the first four months of FY14 (ends March 2014), it reached a level equivalent to 60% of the budgeted fiscal deficit target.
Market is concerned about policy outcomes
Rates-market investors are positioned light ahead of two important policy announcements: the US FOMC and the RBI monetary policy meeting. The outcomes could lead to significant market volatility. We expect the US Fed to taper its quantitative easing by USD 10bn per