RBI cut the SLR by 50 bps to 21.5%.

By Murthy Nagarajan

After having cut the benchmark rate by 25 bps on January 15th, the RBI was expected to remain on hold today.

“The Reserve Bank also indicated that “key to further easing are data that confirm continuing disinflationary pressures. Also critical would be sustained high quality fiscal consolidation…”. Given that there have been no substantial new developments on the disinflationary process or on the fiscal outlook since January 15, it is appropriate for the Reserve Bank to await them and maintain the current interest rate stance.”
We have maintained that the budget is a key event and apart from the fiscal trajectory it would lay down the long term economic agenda of the Modi government.

And thus given that potentially this monetary easing cycle is likely to be a long one, it is prudent to wait for the  budget and then re-look at the rate cutting cycle.
We believe that RBI is not as much fixated on the fiscal deficit/ gdp number as much it is looking at the quality of fiscal adjustment on increasing investments/ supply side response and also clarity on taxation.

We thus maintain our expectation of a rate cut post a sound budget. And possibly another 25 bps cut in the June-September quarter post clarity on good monsoons.

Markets though will take the lack of a clear guidance in today’s policy release as a sign of uncertainty on the future rate trajectory.  Also the removal of the reference to inter-meeting rate changes, would mean that the possibility of the next rate action will be pushed back to the next scheduled policy date of 7th April 2015.

We believe that one should take any bond sell-offs as an opportunity to  add duration to play the rate cycle for the next 6-12 months.

The RBI also made certain changes to investments made by foreigners in corporate bonds

1.       They have barred investments in money market funds
2.       They have dis-allowed investments in less than 3 yr corporate bonds (similar to that existing for government bonds)

Prudent moves to ensure that foreigners continue to invest in the longer end of the yield curve and India does not get too much carry-arbitrage driven inflows. The RBI is thinking ahead to a time when any volatility on US Fed rate hikes can be managed in a sustained manner.

(Murthy Nagarajan is the Head -Fixed Income , Quantum AMC)