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Monetary Policy: Even the RBI is banking on election outcome! - Views on News from Equitymaster
 
 
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  • Apr 1, 2014

    Monetary Policy: Even the RBI is banking on election outcome!

    We were not surprised to find these words of the RBI governor in the latest Macroeconomic and Monetary Developments report. "If electoral outcomes fail to provide a stable government, the downside risks to growth could accentuate. To a large part, the recovery remains contingent on improvements in the investment climate.." If at all, it indicated that even the central bank is in a wait-and-watch mode ahead of the elections.

    Policy stance

    In-line with market expectations, the Reserve Bank of India (RBI) in its first Bi-Monthly Monetary Policy FY15 review has maintained a status-quo. The repo rate or the rate at which the Central Bank lends money to commercial banks remains unchanged at 8.0%. Cash reserve ratio or CRR is also kept unchanged at 4.0%.

    Sizeable fall in inflation since December 2013 has enabled the RBI to leave the key rates unchanged in the current policy review. But the risks to retail inflation (current 8%) remain on account of expected subnormal monsoons due to uncertain weather conditions. The GDP growth at below 5% levels is stable, but the signs of economic revival are still distant.

    Economic scenario

    Slowdown in growth in US, UK, Japan and continued sluggishness in Eurozone followed by tepid growth in emerging economies have restricted the global growth. Fiscal adjustments in some economies have dragged the recovery. Back home, while the GDP growth stood modest, the industrial activity continues to be a drag on the economy. Amidst this, the decline in current account deficit (CAD) (0.9% of GDP in 3QFY14) brought some respite signaling reduced external economic vulnerabilities for Indian economy. Also, while the economy is already set on a disflationary path, loss in business confidence and weak fiscal policy defies economic recovery. More importantly, if the election outcomes fail to match the positive expectations, the risks to growth could accentuate. Therefore, an improvement in investment climate can only ensure a stable economic recovery.

    The way forward....

    That the inflationary risks have softened is a good sign. However, this is unlikely to sustain as the retail inflation is expected to remain sticky going forward in FY15 too. This indicates the demand-side pressures would continue to stay even in the new fiscal. Moreover, the agricultural output is expected to remain sluggish in the next few quarters ensuring higher inflationary pressures.

    Depending upon the inflationary outcome, the RBI expects GDP growth to settle down in the range of 5-6% in FY15. Besides, moderation in CAD during FY14 brought cheers to the economy and markets alike. However, during FY15 the CAD is expected to hover around 2% levels. But despite few positive economic developments, the consumption and investment demand continues to remain subdued.

    The central bank too is banking on the election outcome. With a new and stable government in power, favorable developments such as structural reforms and the fiscal consolidation are expected to tame inflation and stoke growth rates. Easing of supply bottlenecks and clearing of stalled projects would be instrumental in lifting corporate profitability. This coupled with improvement in liquidity conditions would also provide the much required boost to the credit growth.

    However it would be too premature to estimate the impact of reforms on RBI's policy stance since global geo political risks can also play a part. Hence we believe that investors have very little reason to change their allocation in response to Monetary Policy or ahead of elections.

     

     

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