'Hikes on expected line'

The financial sector has welcomed the Reserve Bank of India's (RBI's) move to increase policy rates to check inflation. Most industry representative said the rate hikes were on the expected line. Following are some industry reactions:

Meera Sanyal, Country Executive- India, RBS
RBI's policy action is a little more aggressive than widely anticipated. The central bank has gone a step ahead from the calibrated pace of policy tightening it has followed until now. Its action is however, consistent with the need to curb wide spread inflationary pressures. Clearly strong and generalised nature of inflation coupled with confidence on improving growth conditions, has forced the central bank to act with more urgency.

By narrowing the rate corridor to 1.25 per cent from 1.50 per cent, RBI has ensured that the short-end rates remain anchored around a higher rate even when liquidity conditions go back to surplus. This move, however, will have limited impact now considering that the operational rate at the moment is the repo rate. RBI would have to hike policy rates by another 50- 75 bps during the fiscal year.

With liquidity conditions likely to remain in the deficit mode for a couple of months, rising pace of bank lending and sluggish deposit growth combined with tightening signals from the RBI should translate into higher deposit and lending rates over the next quarter.

RBI‘s decision to do a mid-quarter review of the policy is welcome. This move would facilitate banks to review their loan and deposit pricing more proactively in line with macro-economic conditions.

Saurabh Nanavati, Chief Executive Officer, Religare Mutual Fund
The hike is welcome and on expected lines. We expect RBI to further narrow the gap between repo and reverse repo to 100 bps, from 125 bps currently, the next time it hikes the rates.

 RBI has also indirectly acknowledged the large gap between policy rates and real interest rates and will need to bridge the gap sooner than later. We expect another 50-75 bps hike in interest rates from here before the calendar year is over.

 While RBI has increased the inflation target to 6 per cent by year-end, we feel the numbers will be more in the 7-8 per cent range. Rising inflation remains a very big concern for India’s long term structural growth story.

 We expect short term rates to ease marginally by 25 bps in August due to technical liquidity factors while the 10-year yield should start inching up to the 7.75 – 8 per cent range. Structurally, lending as well as deposit rates will rise by 50 bps from here on in the next 3-4 months.

Vijai Mantri, Managing Director & Chief Executive Officer, Pramerica Mutual Fund
Having steered the economy out of the global crisis, RBI has now zeroed on containing inflation. Timing is good as good monsoon and stable commodity prices will aid to RBI's objective of moderating inflation. Narrowing of rate corridor highlights RBI's increased concern with sharp rise in inflation. Rates will need to be hiked further for a sustained and meaningful improvement in inflation situation. As economic momentum gathers further strength, RBI will have more elbow room to change interest rates.

Navneet Munot, Chief Investment Officer, SBI Mutual Fund
We expect a structural change in liquidity situation with a balanced liquidity in banking system to be the best case scenario in the foreseeable future. Days of extremely easy liquidity are behind us. Money supply growth would be muted and LAF operations are likely to remain in deficit to marginally positive range over the next one month.  Though the concerns on government finances have receded, the hawkish stance of RBI and tight liquidity would keep the downside potential in yields under check. Both G-sec and credit markets are likely to move in trading range with upward bias and also likely to exhibit higher volatility. Having said that, we believe, there would be interesting opportunities of trading on the curve. We expect marginal steepening over the next few days driven by large bond maturities and temporary improvement in liquidity conditions. Curve is likely to flatten in the next quarter as liquidity remains tight, policy rates inch up while long bonds would react positively to containment of inflationary expectations. Short-term yields may soften marginally from current levels, however, the relief would be temporary given the demand supply dynamics and structural tightness in systemic liquidity.

We recommend investors with risk appetite to invest in short-term fund and income fund which are positioned to take advantage of these opportunities.

Ritesh Jain Head, Fixed Income, Canara Robeco Mutual Fund
RBI’s move would ensure that the policy rates are in sync with current market conditions, and at the same time ensure price stability necessary for supporting growth.

RBI has kept the CRR unchanged at 6 per cent and stressed upon the fact that liquidity situation plays a significant role. We believe that RBI would keep just enough liquidity in the market to support growth and normal functioning as excess liquidity would dilute the efficacy of policy rate action.

We believe that RBI’s action would keep the bond market range-bound in the near future, but in the medium term, we are bullish on long bonds as yield curve flattens on RBI's resolve in fighting inflation. The benchmark 10-year government bond is likely to trade in range of 7- 7.25 per cent by March 2011.

Sudhakar Shanbhag, Chief Investment Officer, Kotak Mahindra Old Mutual Life Insurance
RBI is effectively balancing growth and inflationary trends, by adopting a calibrated approach towards normalisation of monetary policy. We expect the RBI to continue to take rate increase measures until clear signs of inflation control are in sight, since growth seems to be on a firm footing, which has been confirmed by increase in GDP growth estimate from 8 per cent to 8.5 per cent and year-end inflation estimate from 5.5 per cent to 6 per cent. The current issue which needs to be addressed is the system liquidity, which has been around Rs 50,000 crore negative for a longer period of time than expected, though the maturity of Rs 30,000 crore on July 28, 2010 and government spending is expected to get the liquidity to better levels than the past 6-8 weeks. Based on the current credit and deposit growth trends and the rate increases by RBI, the banking system would look for increase in deposit and lending rates. The 10 year G-Sec rate is expected to trade in a range of 7.60- 7.80 per cent in the immediate term.

Lakshmi Iyer, Head, Fixed Income and Products, Kotak Mutual Fund
The 50 bps hike in reverse repo to 4.5 per cent and a 25 bps hike in repos rate to 5.75 per cent, the RBI has narrowed the LAF corridor to 125 bps. This action stems from the intent that the RBI wants to ensure that excess liquidity does not dilute policy rate effectiveness as also reduce volatility in overnight rates. Also, it now seems that we would see the repo rate being the operational rate in the near term as the system migrates from surplus to deficit liquidity mode.  The rate hike also reflects RBIs concern on inflation now being generalised and demand side pressure too clearly evident.

Sujoy K Das, Head, Fixed Income, Bharti AXA Investment Managers
Prima facie, the twin rate hikes is expected to push the shorter segment of the yield curve (less than one year) slightly higher and maintaining it in a narrower band than earlier. Some of the expected movement has already been captured.

The more important focus will be on liquidity. It is fairly clear by now that the RBI and the government are deliberately ensuring tighter liquidity to keep the money in circulation low, and hence trying to keep inflation under control. In our assessment, RBI wants to maintain moderate liquidity going forward. One of the ways that liquidity can come into the system is by foreign investment into the Indian market – both equity, and debt. These flows, if left unsterilised will increase the economic base, and increase liquidity. Hence these flows would need to be closely watched as it also impacts inflation.

As per our assessment of maturities, we expect some flows to come into the system in end July to early August. However, going forward, we are entering the ‘busy’ season in the credit cycle, and credit to the various sectors is expected to grow. This increase in the demand for credit, and possible impact of the base rate system, would pressure yields and liquidity going forward. The advance tax flows in September could add to the pressure. This would result in the credit spreads at the short end of the yield curve widening.

Somewhere around September – October, in our assessment, it is expected that inflation will top out and stabilise. This takes into account any possible change of base of calculation in inflation, the lag effect of current and previous rate hikes, demand constriction due to fuel price hike, slowing commodity prices globally due to weak growth, and the arrival of cheaper crops and vegetables due to a moderate monsoon this year. Given this expected trajectory of inflation, it is expected that yields would tend to harden till September – October and then stabilise.