Stock market surprised as RBI keeps policy rates unchanged

The RBI decided not to change the policy rates. They remain:

•        Repo 7.75%

•        CRR 4%

•        Reverse repo 6.75%

•        MSF and Bank Rate 8.75%

The market was expecting a 25 bps hike in the repo rate due to the high CPI (11.2%) and WPI (7.5%) readings.

We too expected a 25 bps hike. So while this “non-hike” surprises us, as we noted on the Monday morning call, over the last couple of weeks, Rajan has indicated that the RBI will increase liquidity in the near term. He believes inflation is already on its way down because food price inflation will moderate and some vegetable prices will actually fall. Whereas growth remains weak with last week’s Industrial Production at -1.8%.

Also, in recent public fora, the FM has repeatedly argued against further rate hikes.

No change to our fixed income strategy. We’ll continue to recommend long-duration bonds / funds to long-horizon (3 years or greater) investors and recommend that short horizon investors invest in liquid funds, FMPs and selected arbitrage funds.

There is continued risk that yields may spike in the next few months.

Guidance from the RBI:

“The policy decision is a close one. Current inflation is too high. However, given the wide bands of uncertainty surrounding the short term path of inflation from its high current levels, and given the weak state of the economy…”

“…if the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the next round of data releases, or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted…”