The Reserve Bank of India (RBI) today announced its third quarter review of monetary policy for 2009-10. The fact that the central bank is worried about thespiraling effect excess liquidity on inflation is clearly indicated in the third quarter review.
RBI has stated that though the inflationary pressures in the domestic economy stem predominantly from the supply side, the consolidating recovery increases the risks of these pressures spilling over into a wider inflationary process. The RBI also believes that the recovery is yet to fully take hold.
The RBI has increased the Cash Reserve Ratio (CRR) by 75 basis points from 5% to 5.75%. The increase in the CRR will be done in a phased manner in two stages:
First Stage:Increase of 50 basis points will be effective the fortnight beginning February 13, 2010,
Second Stage: Increase of 25 basis points effective the fortnight beginning February 27, 2010.
We believe that this is an indication from the RBI exiting from its earlier accommodative policy.
The other highlights of the monetary policy review are as follows:
- Bank rateleft unchanged at 6 percent
- Repo rate has been left unchanged at 4.75 percent: The repo rate is the interest charged by the central bank on borrowings by the commercial banks. A hike in the same means increased cost of borrowings for commercial banks.
- Reverse Repo rate untouched at 3.25 percent: The reverse repo rate is the rate at which the central bank borrows money from the commercial banks. An increase in the same makes it more attractive for commercial banks to park funds with the central bank.
- Statutory Liquidity Ratio (SLR) has been left unchanged at 25 percent:SLR is that amount which a bank has to maintain in the form of cash, gold or approved securities. The quantum is specified in terms of percentage of the total demand and time liabilities of a bank.
- GDP estimate: The RBI has projected that the overall GDP growth rate for 2009-10 will be 7.5%. This is after factoring near zero growth in agricultural production and continued recovery in industrial production and services sector activity.
What to expect in the near future?
Mutual funds could face some redemption pressure from banks due to the liquidity tightening.
No major changes are expected from banks in their lending rates.
There might be a possibility of a rate hike before the next meeting for monetary policy 2010-11, which will be held on April 20, 2010.
What should Debt fund investors do?
Debt funds are not the ideal investments when interest rates in the economy are expected to move up. This is because the bond price and interest rates are inversely related to each other. In the current scenario, we recommend that investors stay away from pure income and government securities funds till Q1 of 2010-11.
Investors with a short-term time horizon would be better off by investing in liquid and liquid plus funds for the next 3-4 months; while the medium term investors with an investment horizon of over 6 months can allocate their investments in floating rate funds.
Investors should refrain from investing immediately in fixed deposits till a further increase in deposit rates offered by banks.
What should equity investors do?
The Indian equity markets have corrected by around 8% from its high of 17,701 on 6th January 2010.We believe that these are opportune times for investors to buy fundamentally sound stocks and/or mutual funds and stay invested for long-term.
Investors should continue to invest in diversified equity funds preferably in a phased manner through SIP, in order to manage the current volatility witnessed in the equity markets.
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