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Softening of Policy Rates Inevitable

The performance of the economy continues to decline. GDP growth in first quarter declined to 5.5 per cent, from 8 per cent during the same period in FY12. The marginal growth in the mining, manufacturing and trade sectors show that the growth engines have begin to cool down.

With population growth of 1.4-1.8 per cent a year, the net income addition to the economy comes to just 3.7-4.1 per cent. With inflation continuing to remain as stubborn as ever, we might as well begin to call this business phase as onset of 'marginal stagflation'.

As we see it, from the present standpoint, the RBI is currently grappling with three set of dilemmas:

>> Managing trade-off between inflation and growth ;
>> Managing trade-off between short-term rupee volatility and long-term Balance of Payment (BoP) sustainability;
>> Managing trade-off between fiscal consolidation and the social mandate of the political class.

We believe growth could take precedence over all other issues and it is inevitable to see a softening policy bias.

From the market standpoint, the performance of the Sensex and the Nifty last month was at 0.84 per cent and 0.56 per cent, respectively. While this may suggest calmness on the surface, the volatility within mid-cap and small-cap segments remains high. 

FII participation in the spot equities market remained high during the month, with net inflows of around $1.9 billion. The sideward market movement, despite the FII inflows, is indicative that the market may be witnessing a sell-off from domestic retail and/or institutional buyers; and that, possible value opportunities may exist within the market.

The debt market remains bogged down with issues surrounding high supply, stubborn inflation and high policy rates. The moderation in the WPI based inflation, while a positive development, still needs to spill over into core and CPI inflation. 

RBI may also wait to study monsoon and kharif production data before it initiates a more benign policy change. The yields in the market may therefore remain range-bound in the near to medium term.

From the mutual fund industry's perspective, the regulatory changes effected by Sebi regarding the total expense ratio have been a breather for the industry. The mandate will incentivise increased penetration of mutual funds into Tier-II and Tier-III cities. With competitive costing, rising investor awareness and increasing penetration, growth in the mutual fund industry is a matter of time.