Monetary Policy Announcement by RBI

Repo Rate, a Policy Rate, is increased by 50 basis points to 7.25% with immediate effect.

Reverse Repo Rate is increased by 50 basis points to 6.25% with immediate effect.

In line with the Deepak Mohanty Committee’s recommendations, the RBI has introduced a new Marginal Standing Facility (MSF) for banks to borrow up to 1% of their NDTL at 100 basis points over the new Repo Rate. This may enable banks who do not have surplus SLR to borrow over-night money from the RBI at 8.25% pa.

Savings Rate has been hiked from 3.5% pa to 4% pa

Both CRR and Bank Rate has been left unchanged at 6%

Market Reaction:

Market participants found the RBI’s tone and language a bit hawkish than past credit policy tones. Clearly, for the RBI, the priority is to rein in headline inflation as early as they can even at the cost of lower growth going forward. This is a marked departure from their previous Monetary Policy stance of supporting growth while containing inflationary pressures. The RBI has acknowledged that apart from higher global commodity prices, the single important risk may be higher oil prices that will test the assumptions of the budget estimates for the FY2011-12. The RBI is cognizant of the fact that if global commodity prices remain at current level for a longer period, then it will have significant negative implications on government finances going forward.

Given this backdrop, the bond market’s initial reaction was cautious. The benchmark 10Y yield hardened from 8.14% pa before the Policy to 8.21% pa after the Policy. The 5Y OIS level also hardened by 10 basis points to 8.35% pa.

We expect bond prices to remain range-bound with a declining bias in the near-term as market participants may await a revision in the fuel prices and its impact on headline inflation. A lot depends on the trajectory of economic growth and the monsoon, going forward. Although there is perception of a slowdown in the overall economy, market participants are not sure if it is a mid-cycle slowdown, which may result in more rate hikes later when economy accelerates or a cyclical slowdown, which may result in the rates being closer to their peak levels.