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16th June, 2011 RBIs Mid-Quarter Monetary Policy Review - June 2011

In the backdrop of higher inflationary pressures in the system RBI continued its monetary tightening measures. It increased repo rate & reverse repo by 25 bps to 7.5% & 6.5% respectively, and the marginal standing facility (MSF) rate to 8.5% with immediate effect. However, it retained cash reserve ratio at 6%. The RBI's view on rates is based on Growth expectations in advanced economies are visibly moderating, even as inflationary pressures, primarily from commodity prices, have increased. The capacity for conventional policy responses appears limited, with many countries having already committed to fiscal consolidation amidst growing sovereign debt risks. Domestically, inflation persists at uncomfortable levels. Moreover, the headline numbers understate the pressures because fuel prices have yet to reflect global crude oil prices. Domestic Economy Performance GDP growth decelerated to 7.8% in Q4FY11 from 8.3% in the previous quarter and 9.4% in Q4FY10, for FY11, GDP growth was 8.5%. Private consumption was robust, investment activity moderated in Q4FY11. The industrial production with 200405 as the base represents a better coverage of the industrial structure in the country, the new series suggested broadly the same growth of a little over 8% in both halves of the year. While the YoY IIP growth moderated to 6.3% in April 2011, growth in capital goods production at 14.5% was buoyant. During April-May 2011, both exports and imports increased sharply and the trade deficit widened. The progress of south west monsoon 2011 has so far been satisfactory, which augurs well for agricultural production. Non-food credit YoY growth moderated from 21.3% in March 2011 to 20.6% in early June 2011, but remained above the indicative projection of 19%. The YoY deposit growth increased to 18.2% in early June 2011 from 17% in March 2011. Liquidity conditions have remained consistent with the anti-inflationary stance of monetary policy. The Governments cash balances moved from a surplus of INR 890 Bn on an average during Q4FY11 to a deficit of INR 290 Bn during Q1FY12 (up to June 15, 2011). Conclusion Domestic inflation continues to remain high and is much above the comfort zone of RBI. Particularly, non-food manufactured products index rose in May 2011 after showing some moderation in April 2011. Domestic fuel prices do not yet reflect the current trends of global prices. RBI was firm in clearly indicating that the monetary policy would continue to remain anti-inflationary going forward. The rate increase of 25 bps was as per expectations of economists & market and may impact industrial production & economic growth in the short term. The hike is likely to be transmitted in the banking sector as it may face challenges in retail finance & asset quality. Banks margins would be affected temporarily but get adjusted in the due course with better CASA management, cost rationalization & changing of product mix. In the interest rate sensitive sectors like Real estate, Auto, Infrastructure & banks would be affected due to the high interest rate regime. Outlook In the period of next six months we expect monsoon to be normal & well distributed, which could help in better crop realisation. This would taper down the food prices and moderate the inflation within RBI limit. The higher crop relisation will help rural economy to grow and there by supporting the GDP growth in the second half the fiscal 2011-12. This in the due course would maintain the growth in rural economy & support the GDP growth towards 8.5%. The market at present has discounted the rise of 25 bps in interest rates but global concerns still continue to weigh on the markets.

Wealth Research, Unicon Financial Intermediaries. Pvt. Ltd. Email: wealthresearch@uniconindia.in

Shweta Rane| srane@uniconindia.in

16th June, 2011

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