From time to time, Morningstar publishes articles from third-party contributors under the "Perspectives" banner.
Here, Arjun Parthasarathy of www.investorsareidiots.com, a financial website for investors, says the Reserve Bank of India will easy monetary policy further during its review in March.
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The 50 basis-point cash-reserve ratio (CRR) cut by the Reserve Bank of India in its monetary policy review on the January 24 is the first of many rate cuts that will happen in calendar year 2012.
The RBI is likely to cut CRR and repo by 50 bps each in its mid-term policy review on the March 15 and this expectation of rate cuts will keep equity, bond and currency markets on a bullish mode going forward.
Tight liquidity conditions forced the RBI to cut CRR by 50 bps to release Rs 32,000 crore of liquidity into the system. The market was borrowing over Rs 1,50,000 crore from the RBI on a daily basis until last week, despite RBI buying over Rs 60,000 crore of bonds and the government running around Rs 15,000 crore of overdraft with the RBI.
The CRR cut will ease liquidity, but the Rs 32,000 crore of liquidity released will not be enough to bring down the liquidity deficit significantly. The last quarter of the financial year is traditionally a liquidity deficit quarter and the month of March usually leads to high demand for funds by the system.
Liquidity deficit in March could be well over Rs 100,000 crore even after the CRR cut, RBI bond purchases and government spending. Hence, the RBI will have to cut CRR in March by 50bps to ease liquidity pressures.
The central bank has stated that the CRR cut is an indication of the change in its policy stance from tightening policy to easing policy rates. The timing of rate cuts is not given by the central bank but the trajectory of inflation will be clearer in March and is more likely to be below RBI's forecast of 7%.
The government will be presenting its budget for 2012-13 on March 16 and will sound out that it is addressing its fiscal issues in the budget. The RBI cited government's spending on subsidies as a factor for not reducing repo rates, and if government can show better fiscal management in its next year's budget, it will cut repo rates confidently.
Revision of GDP growth for 2011-12 from 7.6% to 7% is an indication of private demand coming off in the economy. The fall in credit growth to below 16% levels from around 22% levels in the beginning of fiscal 2011-12 signifies lack of risk appetite by lenders in an uncertain economic environment.
The fall in corporate investment intentions by 77% in the second quarter of 2011-12 on a year-on-year basis signifies the lack of investment demand in the country.
Tight liquidity condition coupled with interest rates staying high in the system will lead to a slow fourth quarter GDP growth. The RBI will have more reasons to cut repo rates in March given growth slowdown.
The markets have been bullish going into the policy with equities rallying by over 8% month to date and the rupee appreciating by over 5%. Bond yields have come off by 20 bps since the beginning of January 2012.
The markets will continue on its broad uptrend on expectations of more rate cuts in March, but given the sharp rally this month volatility will increase.