For FY2011, the stance of the monetary policy remained to anchor inflationary expectations. In Annual Policy 2011-12 also the major policy stance continues to be to foster an environment of price stability that is conducive to sustaining growth in the medium-term, coupled with financial stability.

Based on the recommendations of Working Group to Review the Operating Procedure of Monetary Policy, chaired by our Executive Director, Deepak Mohanty, and in light of the feedback received, RBI has decided to make the following changes to the operating procedure of monetary policy:

• The weighted average overnight call money rate will be the operating target of monetary policy.
• The repo rate will be only one independently varying policy rate, which would more accurately signal the monetary policy stance.
• The reverse repo rate will continue to be operative, but it will be pegged at a fixed 100 basis points below the repo rate.
• Instituted a new Marginal Standing Facility (MSF). Banks can borrow overnight from the MSF up to 1% of their respective net demand and time liabilities or NDTL. The rate of interest on amounts accessed from this facility will be 100 bps above the repo rate.

These changes in the operating framework, except that pertaining to the MSF, will come into force immediately. The MSF will come into effect from the fortnight beginning 7 May 2011.

Pending a final decision on deregulation of Saving Bank Deposit Rate, RBI has decided to increase the savings bank deposit interest rate from the present 3.5% to 4.0% with immediate effect. Reserve Bank has put out a discussion paper debating the pros and cons of this proposal. It will review the policy of deregulating the savings bank deposit rate based on the feedbacks.

Expected Outcomes

• contain inflation by reining in demand side pressures, and anchor inflation expectations; and
• the actions are expected to sustain growth in the medium-term by containing inflation.

Growth to moderate to 8.0% in FY2012

RBI expected the GDP growth at 8.6% for FY2011, but it projected the GDP growth to moderate to 8.0% during FY2012 owing to high oil and other commodity prices and the impact of the Reserve Bank's anti-inflationary monetary stance. The growth forecast for FY2012 is based on the assumption of a normal monsoon, and crude oil prices averaging US$110 a barrel over the full year 2011-12

Keeping in view the domestic demand-supply balance, the global trend in commodity prices, and the likely demand scenario, RBI's baseline projection for WPI inflation for March 2012 is 6% with an upward bias. RBI expects the inflation to remain at an elevated level in the first half of the year, before gradually moderating to 6% by March 2012. This trajectory is conditional on appropriate policy actions over the year.

• When administered fuel and power group prices might be revised and by how much.
• the outlook for crude oil prices in the near future is uncertain and the likelihood of oil prices moderating significantly is low.
• sharp increase in the prices of several important industrial raw materials as well as upward pressure on wages.
• The behaviour of the monsoon

Monetary Aggregates

Keeping in view the need to balance the resource requirements of the private sector and the budgeted government borrowings, M3 growth for 2011-12, for policy purposes, is placed at 16.0%. Consistent with this, aggregate deposits of SCBs are projected to grow by 17.0%. Growth in non-food credit of SCBs is projected at 19.0%. These monetary projections are consistent with the growth and inflation outlook. As always, the numbers are provided as indicative projections and not as targets.

Risk Factors

• Global recovery may slacken due to sovereign debt problem in the euro area, high commodity prices, possible abrupt rise in long-term interest rates in advanced economies and accentuation of inflationary pressures in emerging market economies, impacting domestic economy through trade, finance and confidence channels.  
• Global commodity prices, particularly oil, are a significant risk factor for both domestic growth and inflation.
• The achievement of the fiscal targets set out in the budget could be challenged by the higher subsidy burden stemming from higher international crude oil prices.
• Persistently high food prices are likely to exert sustained upward pressure on wages

Exports showed remarkable buoyancy in the last quarter of FY2011. The current account deficit (CAD) was 3.1% of GDP for the first three quarters, April-December 2010. Factoring in the better performance in the last quarter, RBI estimated the CAD to have moderated to around 2.5% of GDP for the full year 2010-11 as compared with 2.8% for the year before 2009-10.

Developmental and Regulatory Polices

Malegam Committee on Regulation of Micro Finance Institutions

The Reserve Bank broadly accepted the framework of regulations recommended by the Malegam Committee Report on Regulation of Micro Finance Institutions. RBI adjusted some of the parameters recommended by the Committee. Bank loans to all MFIs, including NBFCs working as MFIs on or after 01 April 2011, will be eligible for classification as priority sector loans if, and only if, they conform to the regulations formulated by the Reserve Bank. As recommended by the Malegam Committee, the Reserve Bank has also decided to appoint a Committee to review the priority sector lending classification

Financial markets

• Reserve Bank will shortly issue the final guidelines on credit default swaps. 
• Period of short sale in government securities will be extended from the existing five days to a maximum of three months.
• FIIs will be allowed to cancel and rebook up to 10% of the market value of the portfolio as at the beginning of the financial year.

Regulatory measures for commercial banks

• Provisioning requirements on certain categories of non-performing advances and restructured advances will be enhanced.
• Investment by banks in liquid schemes of debt oriented mutual funds will be subject to a prudential cap of 10% of their net worth as on March 31 of the previous year.
• Banks to ensure that at least 25% of the new branches being opened during this year are located in tier 5 and tier 6 centres.

Dr. Devendra Kumar Pant, Director, Fitch Ratings India

Movement from gradual tightening process of 25 bps to 50 bps is forward looking monetary policy. Petroleum price hike is overdue and likely to be announced soon after the state election, this along with other commodity price increase will have an impact on inflation. There will be some growth consequences of monetary policy. Growth of interest rate sensitive sectors such as automobiles, consumer durables and housing will be adversely affected. While low interest rate bodes well for investment, it is not the sole determinant of investment. Conducive policy environment plays a far bigger role in investment decisions. It is difficult to quantify growth impact of monetary policy at this point of time; however, an 8% growth with low inflation is certainly better than 8.6% growth with 9% inflation.

Sunil Mehta, Country Head and Chief Executive Officer, AIG India

Increase in savings bank deposit rates from 3.5% to 4.0% is a step in the right direction with the ultimate objective of market driven returns for the retail customers. The new provisioning norms are also timely given the current economic situation, pressure on corporate margins due to increasing input costs and higher cost of capital. The RBI needs to be complemented for its pre-emptive policy measures in a complex macro economic environment.

Changes in the operating procedure of the monetary policy to a single independently varying policy rate is expected to more accurately signal RBI's monetary policy stance going forward. Extending the period of short-selling of Central Government's securities from the existing five days to a maximum period of three months will provide impetus to interest rate future and term repo market. Limiting bank investments to 10% of their networth in liquid schemes of debt oriented mutual funds may lead to lower AUMs. However, RBI has again taken appropriate steps in reducing systemic risks during stress / liquidity crunch.

The RBI has increased repo rate by 50 bps as against the earlier calibrated trend of 25 bps. The RBI also acknowledges the persistence of high inflation for the first half of 2012. We expect bond yield to continue to be under pressure due to continuous supply, strained liquidity in the system and continuance of the negative stance on inflation. Worries about earnings growth impact owing to impact on end demand, margin compression and expectation of FII selling is expected to keep the equity markets under pressure.

The 50bps increase in repo and reverse repo rates came in along expected lines. We share RBI's concern that, sustained high inflation can create uncertainties in the economy and may impact investments and growth.

RBI's endeavor is to protect the high growth in the long term at the cost of some moderation in the near term. Its forecast on GDP for FY12 at around 8% clearly reflects that.

The increase of 50bps in savings interest rate was a surprise and is expected to have a marginal impact on the NIMs of banks. They may pass it on to the consumers in due course of time.

Moreover, the revised provisioning norms will impact banks (mostly PSU banks) to some extent. We understand that, most private sector banks and large PSU banks follow a more conservative policy on provisioning. To that extent, they may not be impacted.

We think the RBI has acted decisively to stem inflationary risks, and will continue to do so. The larger than consensus increase in repo, increase in savings rate, and in the Marginal Standing Facility rate to repo +100 bp are all hawkish. We think the RBI will continue on this path, and we reiterate our higher than consensus view of 75 bp of rate hikes going forward. We think the swap curve will sell off on the back of this policy announcement.

The 50-bp rise in the repo rate was consistent with the messages stemming from RBI in the past couple of months and signifies its commitment to combat inflation. The decision to raise the regulated rate on savings deposits by 50-bp adds to the tone of monetary tightening. Together, these steps tend to weaken the growth outlook for FY12. RBI has added to this message by forecasting FY12 real GDP growth in an unusually wide band of 1.1% with a low 7.4% at the lower end. Another message that could disappoint the markets is the upward bias to the inflation guidance for the year.

Akshay Gupta, MD & CEO, Peerless Funds Management Company

RBI's Credit Policy has attempted to address the key issue of anchoring inflationary expectations by accelerating its measured stance of increasing rates. Both repo and reverse repo rates have been hiked by 50 bps, which should temper demand in the short to medium term. It has also made structural changes that will simplify the policy rates interpretation and leave a lot lesser to speculation each time RBI comes forth with a policy. In the context of rise in commodity prices globally, RBI's hawkish stance is appropriate. That said, RBI has not completely sacrificed the growth plank by articulating that liquidity measures in the Banking system will be adequate. While we continue to be bullish on the India story due to its relative attractiveness and global liquidity scenario, we are bearish on Interest rate sensitive sectors like Banking, NBFCs, Auto, and Real Estate etc in the short term. The policy also brought some cheer for the retail bank clients in form of savings rate hike after 9 years.

Vikram Kotak, Chief Investment Officer, Birla Sun Life Insurance

The RBI hiked repo & reverse repo rates by 50 bps to control inflation, which is expected to remain at elevated levels in FY12 as well. In our view, 25 bps hike would have been sufficient since along with accentuating inflationary pressures, downside risks to growth are also clearly emerging. The investment activities remain subdued, pace of monetary expansion is not excessive, credit growth reflects mainly higher working capital rather than strong demand & asset price inflation remains moderate. Further, considering a 2-3 quarter lag in monetary policy transmission, the full impact of earlier tightening is yet to reflect in the economy. Mandating banks to open 25% of new branches opened during a year in unbanked rural centres, 50 bps hike in savings bank account interest rate to 4% & policy of having a single independent policy rate (repo rate) are good moves. Going forward, the RBI is likely to continue with its hawkish stance & in the growth vs inflation trade-off, the policy is likely to remain tilted towards inflation control."

Anil Kothuri, EVP , Edelweiss Housing Finance

Interest rates on Home Loans will increase, mirroring the 50 bps hike in policy rates. This, coupled with the steep rise in property prices over the past year will moderate the demand for Home Loans in the short term. Also, existing borrowers could see the installments on their loans go up.

RBI has taken an aggressive stance in order to rein in inflation and reinforce its inflation-fighting credentials. The willingness to sacrifice near-term growth in order to ensure medium-term sustainability is desirable at this point, given that price pressures are becoming more generalized. The Central Banks growth projections of 8% in FY12 are largely in line with our expectations. The inflation projection, however, is vulnerable to upside revisions depending on movement in global commodity prices and quantum of pass on of administered products prices. Moving to one independent policy rate (repo rate) would help improve the signaling of RBI's stance.

The 50 bps policy rate hike by the RBI today is too late to impact inflationary expectations meaningfully. Inflation is likely to peak at 11.5-12% (final estimate) around Sept/Oct, with the average for H1 and FY12 in our estimates at 10% and 8% respectively. The RBI has projected the H1 average and end-FY12 headline inflation at 9% and 6% respectively. Better late than never... Repo rate has now become the single operative policy rate to ensure more accurate signalling of policy stance. We see significant risks to our GDP estimates for FY12, although we would prefer to wait till we get the new IIP series. On monetary policy road ahead, we have an additional 75 bps of rate hike through 2012, thus revising the total quantum to 175 bps for FY12

The message of the credit policy is loud and clear: it is "reining in inflation even it means sacrificing some growth in the short term." The fact that eight successive rate hikes during the last one year, aided by a normal monsoon and good harvest, didn't arrest inflation and the criticism that RBI has been behind the curve with baby steps, must have forced the Central Bank to take a hawkish monetary stance. RBI has hiked the repo, reverse repo and SB interest rates by 50 basis points each. This tightening is expected to bring inflation down to 6 percent by March 2012. This also means that the growth rate of the economy for FY 2012 will have to be revised down to around 8 percent. The stock market, it appears, has over reacted. For long term investors, big dips will provide buying opportunities, particularly in banking stocks.

Commenting on 50 bps increase in repo and reverse repo rates, Dr. Renu Pothen, Research Manager, Fundsupermart.com said "RBI's increase in the policy rates by 50 bps is a clear indication that the Central Bank is continuing its aggressive policy stance to reduce inflationary expectations. The uncertainties in the global markets and domestic factors will lead to high inflation numbers in the coming months which means that more rate hikes are on its way. RBI has increased the rates nine times; however, the inflation has marginally reduced from 10.23% to 8.98% indicating that the monetary policy has not been successful in reducing inflation.

We continue to believe that the government will have to take appropriate steps to contain inflation otherwise, the monetary tightening policy will only hamper consumer's purchasing power, corporate profitability, but also, the growth prospects of the Indian economy.

Impact on banks

The rising interest regime is leading to hardening yields, which shall dampen the treasury income of banks. Also, the interest on savings deposits have been earlier shifted from the least amount held between 10^th and last day of the month. But from 1^st April 2011, as per RBI's directives, they have started paying interest on daily balance. Now RBI has hiked this rate from 3.5% to 4.0%.

As per Capitaline Databases, the aggregate savings deposits of 29 banks were about Rs 887267.27 crore in FY 2010, out of total deposits of Rs 3764736.04 crore. This means, that about 23.6% of the total deposits were savings account. On a simple calculation, this means about 14% increase in interest on savings deposits of the above sample from about Rs 30154 crore at 3.5% to Rs 35491 crore at 4.0%. But factoring in the shift to interest on daily balances, the actual impact for / from the current fiscal will be significantly higher from the previous year levels. There will be a minimum 10 basis point increase in cost of deposits, on account of increase in interest on savings bank account, without even factoring in the shift in calculation to daily balance method. But the impact differs from bank to bank, depending on the share of savings account in their total deposits.

Also, banks are likely to increase interest on both lending and advances. This can affect the rate sensitive sectors like automobile, real estate, construction etc. High inflation and hardening interest rates can also affect the pace of growth in economy. As a result, there is a distinct possibility of increase in NPA levels of the banking sector.

RBI had no option but to take aggressive stand, considering the unacceptably higher inflation, and as it is becoming more generalized. Still, factoring in the domestic demand-supply balance, the global trend in commodity prices, and the likely demand scenario, RBI's baseline projection for WPI inflation for March 2012 is only 6%, but with an upward bias. It expects inflation to remain at an elevated level in the first half of the year, before gradually moderating to 6% by March 2011.

Already, the pace of growth in Index of Industrial production has tumbled down sharply from record 16.6% in April 2010 to mere 2.5% in December 2010 and 3.6% in February 2011. RBI acknowledged that High oil and other commodity prices and the impact of the anti-inflationary monetary stance will moderate growth. Assuming a normal monsoon, and crude oil prices averaging US$110 a barrel over the full year 2011-12, RBI has come out with benign baseline projection of 8% growth in GDP for 2011-12, for policy purposes. Perhaps, reining in inflation should has taken precedence even at some short-term costs by way of lower growth. So, expect more tightening of monetary policy through the fiscal, especially in the rest of the first half of the current fiscal.