The stance of the Reserve Bank of India’s (RBI) July Monetary policy review has clearly shifted towards keeping liquidity in balance mode to enable a more effective transmission of monetary policy. The intent of keeping the repo rate as the signalling rate on a sustained basis is expected to keep the cost of corporate borrowing firm. We are at the beginning of an increasing interest rate cycle and with credit growth at about 22 per cent, banks are gradually gaining pricing power. We expect deposit rates to start inching upwards before lending rates do. Interest rates are likely to move up secularly over next few months. Thus far, retail lending hasn’t been buoyant but come October, the retail lending is likely to pick up which will put pressure on rates. We anticipate one year deposit rates to move towards 7.50-8 per cent. We also expect teaser rates in mortgages to stop. We have been highlighting over the past few quarters that the personal loans segment (housing, credit cards, durable loans etc) has been sluggish in the overall credit universe for quite some time. While there has been a marginal recovery on that front, the overall condition remains the same. We also feel the demand for housing depends on the overall cost of buying a house and till such time as buying a house is affordable, there will be demand from buyers. It may surprise many of us that most of the consumption boom over the last year has not been funded by credit. A part of it can be explained by the large personal income growth of farmers and government/quasi government employees (due to the onetime farm loan waiver, NREGA support, higher MSPs and sixth pay commission revisions). Over the last 6 months the nature of price pressures underwent a change, from being largely supply-induced to demand-push. While the increased pace of private investment spending is expected to reduce the supply-side bottlenecks in the economy, it would also bring along with it commodity and input-price pressures. With the 10 per cent plus industrial expansion in FY10 and the 8.6 per cent GDP growth in the final quarter, the central bank has revised its FY11 growth target to 8.5 per cent from the previous 8 per cent with an upward bias. The FY11 industrial expansion continues to chug along in double digits, with consumption and investment spending expected o support the on-going momentum. The pre-dominance of food price inflation that printed at an average of 15.39 per cent in FY10 has gradually eased to 10.44 per cent in the month of June and the same is expected to further ease in the coming months in anticipation of distinctly better monsoons (expected 102 per cent of the LPA in FY11) and higher crop acreage. The most worrisome aspect is the ‘non-food inflation’ (weighing 52.2 per cent in the WPI) which contributed over 70 per cent to the WPI growth in June, justifying the RBI’s hawkish monetary stance. The trend in non-food inflation reflects a more broad-based inflation averaging currently at 10.2 per cent in the year so far relative to the previous year’s growth of -0.2 per cent. We would expect the non-food component to contribute the most to the imminent price growth in view of the remaining direct and indirect effects of the fuel price deregulation and the greater pricing power of producers that will have an effect in the busy season of the second half. We continue to believe that the short term rates will remain at elevated levels, and the same thought reflects in our ultra short term portfolios, where we have cut the duration risk sharply (both in absolute and relative terms). Our stance of duration remains cautious. As far as the 10-year G-sec is concerned, there is a potential borrowing cut to the extent of Rs 25-30,000 crore in the second half, which may work in favour of sovereign yields, but only relatively. We believe that the middle and the long end of the G-sec curve is mostly normalised and is unlikely to move secularly on either side. Investors should look at liquidity funds as cash management tools, short term funds as investment products for six to twelve months horizon and long term duration funds to park their savings for investment horizon of over an year. u

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