SUBBARAO BRINGS CHEER TO DALAL STREET

By Ruma Dubey

CRR has been cut by 50 bps to 5.5%, effective 28th Jan and this is expected to infuse liquidity to the tune of Rs.32,000 crore into the banking system, which over the next 5-6 months will bring in around Rs.1.5 lakh crore. There is no change in the policy rates, thus repo rates remains unchanged at 8.5% and reverse repo at 7.5%.

Headline inflation has come down and hence by CRR cut is has chosen to send the signal that though it maintains its dovish stance on inflation, it is now equally concerned about growth too and this quantitative easing of liquidity is a positive move to address this threat. It also sends a signal that it the lid is maintained on inflation, if food and manufacturing inflation does cool down, we could see reduction in policy rates in the next ensuing policy.  Food inflation is expected to fall till March secondary effect of which could be on manufacturing, which could also see softening by March.

RBI cut GDP forecast for FY12 from earlier 7.6% to 7%. It kept inflation forecast unchanged at 7%.

Structural deficit exists in the system despite more than adequate liquidity and this is what RBI has tried to address through a CRR cut. The objective is three pronged - maintain an interest rate regime which contains inflation, manage liquidity to ensure it remains at modest levels and respond to increasing threat to the downside to growth.

Does this mean that banks will now cut rates with the 50 bps cut in CRR? With more liquidity being infused into the banking system, it is expected that there would be a marginal cut in rates – around 5 to 10 bps but nothing more than that. Thus any rate cut before March seems unlikely.

Bond yields will ease as liquidity eases and this is good for the banking sector as it eases pressure on the margins in the coming days. We are now on a monetary easing cycle and this is good news for banking stocks. Things will change for the good but slowly and steadily. Yes, it seems like good times are coming in for equities but remember this is a slow process. Q3 numbers till now have come a little ahead of expectations and thus we could see some improvement in sentiments going ahead. Growth remains a concern but this softening stance on monetary policy indicates that in FY13 we could see things improving. Global concerns remain but if moods get optimistic, domestic demand in itself is enough for us to sustain these precarious times.

This infusion of liquidity will reduce the downside threat to growth. It has sent out a message to India and its politicians that it has done its job and now the onus is on them to bring about a logical Budget and not a populist one. RB has done its job and it is now up to the Govt to present a Budget which concentrates in fiscal consolidation. It has also sent out a message to the international community that it is going slow and steady; doing what it thinks is right and is not guided by what the FIIs want. This tight rein on the need to go over broad, refraining from giving in to what the markets want and choosing to keep the needs of the economy prime, Mr.Subbarao has indeed done the best possible thing. Maintaining this restraint reflects the fact that RBI is indeed much sane and yes, we probably have one of the best decision makers in Subbarao. More power to him!