Mumbai: Improvement in liquidity condition is unlikely to help ease short-term rupee overnight index swap (OIS) rates below 7.75 percent, as RBI may not slash policy rates at its upcoming meeting, says a report.
"A moderate improvement in liquidity will not be sufficient to push front-end swap rates below the 7.75 percent as the RBI is likely to hold the rates," DBS said in the report on Monday.
The Asia's leading financial services firm sees the one- year OIS rate hovering between 7.75 and 8.25 percent in the medium-term. However, in the short-term there is scope for front-end rupee OIS rates to head lower as risk premia become more compressed.
DBS, which expects the RBI to keep rates unchanged at January 28 monetary policy meeting, sees a 25 basis points cut in the March quarter. "The bias will still be to tighten rates if the recent drop in inflation proves transitory."
The report said although stable currency and fall in vegetable prices led inflation to ease in December, it would be premature to assume that trend would continue as factors responsible for higher prices have not been resolved.
"Factors that underpinned price trends prior to the July- November peak have not been addressed and persist despite subdued consumption spending and tight monetary policy."
Wholesale price based inflation eased to 6.1 percent in December from 7.52 percent a month earlier while retail inflation came down to 9.9 percent from 11.6 percent.
The report said there is a need to arrest inflationary expectations which continues to be stubborn.
Higher inflationary expectations could soar in the event of supply- shocks that might come from the commodities space or another disruption in food supplies.
"These two factors thus necessitate a policy response from the central bank, despite the fact that monetary policy is a blunt instrument and not very effective in addressing inflation driven by the supply-side."
DBS said higher rural demand, firm real wage growth, rise in operational cost are some of the factors that would impact inflation.
"The bottom line is that the RBI cannot fight inflation alone, especially if the fiscal policy is moving the other way. The supply-side hindrances along with the accommodative fiscal stance need to be addressed."