Easing though liquidity route to continue, 100bps cut in repo rate in 2013

Due to high inflation, the RBI today kept the repo and reverse-repo rates unchanged, at 8% and 7% respectively. However, in order to keep liquidity into its comfort zone, RBI cut the cash-reserve ratio (CRR) 25bps, to 4.25% of net demand and time liabilities (NDTL). The move would inject Rs 17,500 cr liquidity into the system. Taking the liquidity route to ease monetary policy, the RBI has cut the CRR by 175bps in last ten months.

The RBI has revised its FY13 GDP forecast downward to 5.8% from 6.5% in Jul ’12 policy. The WPI inflation target for Mar’13 has been revised to 7.5%, from 7% earlier.  Both deposit and non-food credit growth has been revised downward by 100bps to 15% and 16%, respectively.

100bps cut in repo rate in CY13. Given upside risks to inflation till Dec ’12, a rate cut by RBI until Dec’12 is unlikely. I expect the central bank to focus on easing liquidity through open market operations (OMOs) and by slashing cash reserve ratio. I expect WPI inflation to peak out at 8.5% in Dec’12. Likelihood of a bumper rabi crop and strengthening rupee, coupled with a favourable base effect, are key factors which could soften WPI inflation considerably post Dec’12. I expect WPI inflation to soften to 6.1% in Apr’13. Accordingly, I expect 100bps repo rate cut in 2013 with the first cut starting from Feb-Mar ’13. In its guidance, the RBI also said, “the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of 2012-13”. Until then, the RBI is likely to continue with the liquidity enhancing measures – CRR cuts and OMOs – to support growth.