Review of RBI’s Q2FY09 Monetary Policy

Review of RBI’s Q2FY09 Monetary Policy

The recent RBI policy has left the CRR, Repo and Reverse Repo rates unchanged for the time being in light of the substantial pre-policy easing measures.

The overall real GDP growth for FY09 has also been revised to a range of 7.5-8%, acknowledging the increasing headwinds to growth arising from the ongoing global financial crisis through trade and financial channels.

According near-term priority to financial stability, the policy emphasized the RBI’s focus on preventing pressures from building up in the financial markets. This would include enhancing liquidity if pressures persist.

This could also mean curtailing liquidity if the recent liquidity easing measures were seen to have injected excess liquidity, thereby stoking inflationary pressures.

We believe capital flows continue to dominate the RBI’s monetary policy challenges. In the face of sustained capital outflows, the RBI has infused Rs1,85,000 crore of liquidity into the system through various tools and also instituted several measures to encourage capital inflows, including raising of minimum interest rate caps on ECBs and NRI deposits.

The RBI noted that sustained FDI inflows and higher NRI flows had partly offset the impact of the FII outflows. It expected that overall, during FY2009, while the current account deficit may be higher and net capital flows lower than during last year, but net capital flows would meet the external financing requirements.

We believe such an eventuality could play an important role in mitigating some of the headwinds to growth and money supply in the economy and reduce the necessity of cutting CRR / Repo rates by the RBI.

Overall, we believe the current policy is transitional in its tone, in-line with the dynamic economic situation.

The direction of capital flows could play a key role in determining the further course of action for the apex bank.

While the policy does seek to re-emphasize the RBI’s continued vigil on inflation, we believe it is likely that inflation will trend down over the coming months in light of the sustained demand slowdown across the globe, enabling the RBI to take further softening actions in order to provide demand triggers to the economy.

Advantage banks

While banks stand to gain from increased credit demand and a more accommodative monetary policy in the coming months, asset quality will remain a key factor to monitor.

HDFC Bank and Axis Bank continue to be our top picks in the sector. We believe these private banks deserve premium valuations as they score highly on all competitive parameters underpinning high sustainable RoEs and strong growth outlook.

The banks have attractive CASA franchises and are expected to maintain their significant traction in CASA market share gains. They continue to deliver robust growth across multiple sources of sustainable fee income. In the current environment, their strong liability profiles and healthy capital adequacy make them especially attractive.