DSP BlackRock Assessment on RBI's Credit Policy - Aug 4, 2015

Comment on monetary policy by Mr Dhawal Dalal - EVP & Head Fixed Income - DSP BlackRock

The RBI has maintained a status quo on the Repo Rate as well as other rates in today's monetary policy. This was in line with broad market expectations.

The RBI's assessment of the economy has improved marginally since June amid the recent decline in the commodity prices and better-than-expected rainfall till date. Based on that, the RBI has marginally lowered its inflation guidance for January 2016 and has signaled that risks to its inflation forecast are more-or-less "balanced" as against tilted to "upside" in its June assessment. At the same time, the RBI has mentioned that they were concerned with the trajectory of core inflation which was steadily rising since April 2015 partly due to upward revision in the Service Tax.

The RBI has maintained the same four factors for further guidance on the monetary policy outlook. They are:

- Transmission of previous policy rate cuts by the banking system
- Food price inflation and effect of monsoon
- Continuation & acceleration of government policy action to address supply side concerns, and
- Developments in global markets (the Fed lift-off)

The RBI's forward guidance on rates continues to remain "accommodative" as the RBI is looking out for more headroom to lower rates further.

Based on the recent fall in the commodity prices and emergence of disinflationary headwinds in Asia and Europe, we believe that odds of the RBI reducing the Repo Rate by 25 basis points to 7% in the last quarter of 2015 have greatly improved.

What should investors do?

We continue to remain constructive on government bonds over the medium term (6-12 months).

Although government bond yields have hardened marginally after the Policy statement amid position adjustment, market sentiment remains positive. The benchmark 10Y government bond yields have hardened by around 4 basis points to 7.84% after the policy statement.

Recent slump in the key commodity prices as well as recent decline in global bond yields have once again put the spotlight on the bond market. We believe that improvement in July rains and narrowing of the rain deficit may have set the stage for a gradual decline in the bond yields over the medium term.

Based on our expectations of the Repo Rate @ 7% in the last quarter of 2015, we believe that the benchmark 10Y government bond yield may have potential to decline to around 7.30-7.40% level by March 31, 2016 from a technical perspective.

Source : Equity Bulls

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