The RBI's rate action today was in line with market expectations. Considering inflation being a key concern once can expect another 50bps hike by Dec11. The key take-away was RBI's guidance for the coming fiscal - in terms of growth (where it expects a moderation), inflation (further upside risks on a/c of food and commodities) and liquidity (where-in the structural factors could dominate).

IMPORTANT TAKE-AWAYS FROM THE POLICY

Repo/Reverse Repo Rates raised by 25bps — Time for catch-up as RBI has been behind the curve....In line with expectations, the RBI in its policy today raised its key policy rates by 25bps. The repo (liquidity injection rate) now stands at 6.50%, and the reverse repo (liquidity absorption rate) at 5.50%. Going forward, RBI could raise rates further by another 50bps in 2011.

Guidance – Growth, Inflation and Liquidity — Not a Great Picture......

1. Growth: The RBI has retained its 8.5% GDP estimate for FY11 with an upward bias; however it is cautious on the outlook for FY12 saying that "growth may decline somewhat" due to agriculture reverting to its trend.

2. Inflation: The RBI has raised its Mar11 estimate of inflation from 5.5% to 7%. While it expects headline inflation to moderate in future, it has warned that "several upside risks are already visible" due to global and domestic factors.

3. Liquidity: The RBI has distinguished between frictional and structural liquidity. While frictional liquidity is likely to ease with govt spending, structural liquidity shortages could persist due to the divergence between credit and deposit trends. In the interim, it has extended its liquidity measures until April.

Inflation – Much more than monetory policy needed.....The RBI said that in the growth/inflation dynamics, the balance of risk has tilted towards ‘intensification of inflation’. However, RBI admitted that given the underlying dynamics, the role of monetary policy is ‘confined to containment and prevention of food and energy prices’ from becoming generalized. To this end it has re-iterated that food price scenario is primarily a reflection of structural constraints…and thus ‘unless meaningful output enhancing measures are taken, inflation could become entrenched and threaten the growth momentum’.

Market Impact – With the rate hike in line with market expectations, yields have remained unchanged with the 10-year bond trading at ~8.17% levels.

Investors can take advantage of existing good yields by parking money in ultra short term, short term bond fund and fixed maturity plans.