Moses explains impact of CRR cut on bonds, rupee

Indian economy is struck with weak macroeconomic dynamics of high fiscal deficit, high current account deficit, low growth and high inflation coupled with major risk of sovereign rating downgrade pushing the investment status to junk. It is impossible to address all these issues at the same time because of conflicts in play between growth-inflation dynamics. Therefore prioritisation becomes critical. There has been priority for inflation control since March 2009 with tight system liquidity and high cost of liquidity but met with little success. The adverse direct impact on growth and indirect impact on fiscal deficit has been severe. It was thought prudent (of RBI) to dilute its priority on inflation control and turn growth-supportive to prevent move from bad to worse. RBI also recognised strong positive factors (for inflation) from soft commodities and strong rupee. The expectation on inflation is positive for sharp reversal in Q4 of FY13 and H1 of FY14. In recognition of more downside risks to growth (and investments) and improved expectation on inflation (and twin deficits), the expectation from stake holders (from RBI) was for delivery of rate cut to kick-start rate reversal cycle as shift into dovish monetary policy stance.

The delivery of token 25 bps CRR cut is seen cosmetic when deficit system liquidity is more than 1.25% of NDTL. The stance of RBI is seen as conservative and not cautious post recent developments. So, it is back to waiting-time for shift into rate cut mode, expected to be in January-March 2013. 10Y Bond yield will get into consolidation mode at 8.12-8.17% with March 2013 target at 8.02-7.97%. The impact is neutral on rupee exchange rate to extend its consolidation mode at 53.20-54.20.  

The writer is Head-ALCO and Economic & Market Research