Monetary Policy August 05, 2014: Impact

Contributed by: Jayna Gandhi, CFA

RBI kept all the rates unchanged, however reduced SLR requirement for banks from 22.5% to 22% and HTM category requirement from 25% to 24%

The stance/rationale of this monetary policy was more cautious and directionally hawkish then it was in June 03, 2014 (where the tone was more accommodative for growth revival while anchoring inflation expectation) in a sense that the monetary policy stressed upon its prime goal of inflation management. The policy paraphrased that the fall in CPI inflation for two consecutive months is due to,

  • Strong base effect
  • Steady deceleration in CPI excluding food and fuel items

The policy recognized the concern for upside risk to the inflation going forward due to

  • Pass through of increase in administered prices
  • Continuing uncertainty of monsoon conditions
  • Possibility of high oil prices due to geo political concerns and possible exchange rate movements
  • Strengthening of growth in the face of continuing supply constraints

Accordingly, the risk to CPI inflation target of <8% by January 2015 remain; the overall risk is more balanced then in June 2014. This necessitated leaving the policy rates unchanged.

The Union Budget 2014-15 has renewed its commitment to medium term fiscal consolidation road map and budgeted fiscal deficit at 4.1% of GDP, accordingly space has opened up for banks to expand credit to the productive sectors in response to financing needs as growth picks up. This additional credit flow is provided by reducing the SLR requirement from current 22.5% to 22%, which has a propensity to harden the G Sec yields, as their demand from banks to meet the SLR requirement is reduced. The debt market has already shown its reaction with new 10 year 8.40% G Sec 2024 closing at 8.59% which 8.83% G Sec 2023 ended at 8.81%.   

Along with the above reduction of SLR, the reduction of requirement in HTM category is done to enhance the liquidity in the money and debt markets so that financial intermediation expands apace with a growing economy along with enabling greater participation of banks in the financial market. This may increase supply of debt securities in the secondary market with yields inching upwards.

Takeaways from the Policy

The above action of reduction of SLR and HTM requirement offers opportunity to take duration based calls in the long term debt securities, since, receding of the upside risk to the inflation will glide path of fiscal consolidation Q1FY15 onwards. When RBI may starts easing the rate cycle, and duration calls taken now will results into higher profit generation opportunity.

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