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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 Ė 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 month (USTs only) and maintain a relatively dovish policy tone. The RBIís policy backdrop is somewhat more complex. If the RBI only fine-tunes the existing liquidity framework and reiterates its intent to gradually exit the tight liquidity regime, then we expect a limited market response. The markets will then watch closely for signals from the new Raghuram Rajan on the timeline and possible preconditions for a roll-back of liquidity-tightening measures. However, an announcement that underscores the risks of the re-emerging inflationary pressures may disappoint the rates market. The market would then price in a prolonged period of tight liquidity and high short-term interest rates. Given elevated uncertainty surrounding potential monetary policy responses, we remain Neutral on GoISec duration.
We have a short-term Neutral FX rating on the INR. Heading into Q4, we expect the USD rally to pause on stabilising data from China and an improvement in Asia ex-Japan trade balances, boosting the Indian rupee. An improvement in India's trade deficit should also be supportive. However, the crucial FOMC outcome may lead to considerable US dollar volatility ahead of this. Also, in his 4 September speech, Raghuram Rajan mentioned the possibility of further FX stabilisation measures being announced in the monetary policy meeting. The absence of this could dent the Indian rupee optimism that has been visible since his appointment.
By Standard Chartered