THE RESERVE BANK OF INDIA RAISES INTEREST RATES

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Our Global Multi-Asset Allocation Model has a long allocation to India. The Reserve Bank of India raised its short-term lending and borrowing rates late Friday. It raised the repo rate (rate at which it lends to banks) and reverse repo rate (rate at which banks park their funds with it) by 0.25 per cent each to 5 and 3.75 per cent respectively .

This move by theReserve Bank of India does not change the allocation to India in our model.

The high priests of Indian markets have almost uniformally called this interest rate increase as surprise. We are not surprised. Our model anticipated it since the inflation rate crossed the 8.5% target set by the bank. We think calls from the experts to reduce allocation to India in view of this rate increase are misplaced. As a matter of fact, if there was not a rate increase our model would have reduced allocation due to rising inflation concerns. If the inflation does not cool down, we anticipate further interest rate increases.

The best way to understand India is to to keep a close watch on food inflation. Sometimes experts in the developed world use the same models for India that they use for their own countries. thus leading to their erroneous views. The big difference is that a majority of population in India spends over half their income on food — about 500% of the comparable number in the developed world.

Unlike the developed world, food inflation in India easily and quickly spills into non-food inflation. Fortunately, recently food inflation in India is declining. Food inflation changed from the near 20% in December to 16.3 % in the week ending March 6.

The next Reserve Bank monetary policy meeting is on April 20. Until then it is likely that our model will not change allocation to India. In the meanwhile, we expect March inflation headline number to be over 10%. This number should be adjusted for one time rise in fuel prices and after adjustment we do not expect it to be alarming.

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