In contrast with consensus expectations of a 25 bps rate hike in the first quarter monetary policy review, RBI surprised the markets by increasing the repo rate and reverse repo rate by 50 bps to 8% and 7% respectively. Based on global and domestic factors, RBI feels that the monetary policy needs to continue with its “firm anti-inflationary stance”. 

In its assessment of the economy, RBI felt that notwithstanding signs of moderation, inflationary pressures are clearly very strong, and therefore, inflation continues to be the dominant macroeconomic concern. RBI has noted that demand pressures have continued to remain strong and even though growth is beginning to moderate, there is no evidence of a broad- based slowdown. Hence, RBI has maintained its 8% GDP growth estimate, and has raised its March 2012 inflation estimate from 6% with upward bias, to 7%. 

Going forward, the RBI’s monetary policy outlook will depend on the evolving inflation trajectory, which in turn, will be determined by trends in domestic growth and global commodity prices. 

In the short term, yields are expected to move up. However, effective rate hikes of 475 bps over the last 18 months and any further rate hike (if any) is likely to slow down growth over the next 6 to 12 months. With moderating demand pressures, inflation is likely to trend down and hence yields are expected to head lower in the medium term. 

In view of the above, we recommend investments in Bond funds and G-sec funds in a staggered manner with a 1-2-year view.