Reserve Bank of India checked all the right boxes in Raghuram Rajan’s latest monetary policy. Quite expectedly they refrained to from moving on rates or liquidity measures. RBI has formally adopted the medium term inflation framework, which binds it to a target of 4% with +-2% as upper and lower flanks. Current consumer inflation is at 5.77%, a whisker away from the upper band. At the same time, RBI has guided for upside risks to its inflation forecast of 5% for FY17 end. Therefore there is not much room for RBI to lower rates further. Additionally, Raghuram Rajan has always emphasised the need to maintain real rates positive, to attract savings into the financial assets and also keep the Rupee anchored. He had alluded to a target real rate corridor of 150-200 bps. Currently real rates, difference between 1 year government bond yield (6.84%) and 1 year forward CPI inflation (5.00%), is around 184 bps, well within the RBI’s targeted corridor. Hence, we did not expect any kind of easing in the policy and it was therefore not a surprise to see status quo decision from RBI.
In its outlook on the economy RBI has expressed optimism on improving rural demand and some positive signs in manufacturing. According to RBI, urban consumption remains strong and further boost to consumption can occur from a better monsoon and 7th pay commission. However, it also said that corporate investments remains weak as capacity utilisation levels are still low. On global front they expressed a mixed view, with risks arising after Brexit but stability in commodity prices has reduced the severity of the slowdown in emerging economies.
In a welcome move, RBI has talked about bringing out detailed measures on reforming the financial markets and corporate bond markets on August 25th. Impact has been quite positive on bond market after RBI announced a fresh round of Open Market Operations(OMOs -purchase of government bonds to infuse Rupee liquidity) but Rupee weakened. The opposite reaction on bond and currency is understandable, as more liquidity though is positive for bonds but is negative from a currency perspective. Over the near, we see the risk of Rupee depreciating towards 67.08/15 levels on spot, with 66.60/70 acting as strong floor under USDINR pair.
The author is currency analyst, Kotak Securities.
