The Reserve Bank of India (RBI) today announced its annual monetary policy for 2010-11. The move taken by the central bank is aimed at controlling the spiralling inflation without choking growth.
Inflation, as measured by the Wholesale Price Index (WPI), which earlier moderated in the first half of 2009-10, firmed up in the second half of the year. It accelerated from 1.50% in October 2009 to 9.90% by March 2010.
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The deficient south-west monsoon rainfall have also accentuated the pressure on food prices, thus taking food inflation to a 16 month high of 17.70% for the week ended March 27, 2010.
According to the RBI, three major uncertainties cloud the outlook for inflation:
First - The prospects of the monsoon in 2010-11 are not yet clear.
Second - The continuous volatility in crude prices.
Third - Evidence of demand side pressures building up.
Hence, keeping in view the domestic demand-supply balance and the global trend in commodity prices, the baseline projection for WPI inflation for March 2011 is placed at 5.50%
In order to combat the spiraling inflation, RBI has taken the following measures:
Increased the Cash Reserve Ratio (CRR) by 25 basis points from 5.75% to 6.00% with effect from April 24, 2010.
•Repo rate has been increased from 5.00% to 5.25%: The repo rate is the interest charged by the central bank on borrowings by the commercial banks. A hike in the same means increased cost of borrowings for commercial banks.
•Reverse Repo rate has been increased from 3.50% to 3.75%: The reverse repo rate is the rate at which the commercial banks park their funds with the central bank. An increase in the same makes it more attractive for commercial banks to park funds with the central bank.
The other highlights of the monetary policy are as follows:
•Bank rate left unchanged at 6.00%.
•Statutory Liquidity Ratio (SLR) has been left unchanged at 25.00%: SLR is that amount which a bank has to maintain in the form of cash, gold or approved securities. The quantum is specified in terms of percentage of the total demand and time liabilities of a bank.
The RBI believes that the stance taken in the monetary policy is intended to:
•Anchor inflation expectations, while being prepared to respond appropriately, swiftly and effectively to further build-up of inflationary pressures.
•Actively manage liquidity to ensure that the growth in demand for credit by both the private and public sectors is satisfied in a non-disruptive way.
•Maintain an interest rate regime consistent with price, output and financial stability.
GDP estimate: The RBI has projected the overall GDP growth rate for 2010-11 at 8.00%. This is after factoring in the assumption of a normal monsoon and sustenance of good performance of the industrial and services sectors on the back of rising domestic and external demand.
What should Debt fund investors do?
Debt funds are not the ideal investments in a rising interest rate scenario. This is because the bond price and interest rates are inversely related to each other. In the current scenario, we recommend that investors stay away from pure income and government securities funds till June 2010. However, any mid policy rate hikes will be opportune time for investors to start looking at shorter duration income funds. The first quarter review of monetary policy 2010-11 is scheduled on July 27, 2010.
Investors with a short-term time horizon would be better off by investing in liquid and liquid plus funds for the next 2-3 months; while the medium term investors with an investment horizon of over 6 months can allocate their investments to floating rate funds.
Investors should refrain from investing immediately in fixed deposits till a further increase in deposit rates is offered by banks. One year bank FDs would be attractive only above 7.50%. One year FDs are currently available at 5.00% to 6.50%.
What should equity investors do?
We do not see a rise in interest rates as a source of risk, as it will only moderate growth and not derail it. Moderating the growth is good for the long term growth of the economy.
We believe that these are opportune times for investors to buy fundamentally sound stocks and/or mutual funds and stay invested for long-term.
Investors should continue to invest in diversified equity funds, preferably in a phased manner through SIP, in order to benefit from the volatility witnessed in the equity markets.
source: personalfn.com
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