Sixth Monetary Policy Committee Meeting

The sixth meeting of the Monetary Policy Committee (MPC), will be held on August 2 and 3, 2017 at the Reserve Bank of India. The MPC shall review the surveys conducted by the Reserve Bank to gauge consumer confidence, households‟ inflation expectations, corporate sector performance, credit conditions, the outlook for the industrial, services and infrastructure sectors, and the projections of professional forecasters. The Committee shall also review in detail staff‟s macroeconomic projections, and alternative scenarios around various risks to the outlook. The decision of the MPC shall be in accordance with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth. In this blog, I shall focus on the above mentioned parameters to access the likely policy action to be taken by the RBI in their monetary policy review scheduled next week.

The current scenario of the policy rates is as follows:

  1. Repo Rate – 6.25%
  2. Reverse Repo – 6%
  3. Marginal Standing Facility – 6.50 % (Being pegged at 25 bps to the repo rate from the last policy review since the volatility of the call rates has significantly reduced)

GLOBAL ECONOMIC OUTLOOK:

The global economic activity has been growing at a modest pace, catalyzed by the emerging economies and some of the advanced economies. US markets have benefited from the wage gain and the industrial production has been steadily improving. However, US continues to face ebbed sales figures at home. The Euro zone continues to struggle in their movement towards growth. The political risk continues. Japan seems to be struggling with the subdued domestic demand and the political instability concerning the removal of Abby. Among the emerging economies, China has shown significant signs of stability, Russia has been witnessing improved recovery in their macro fundamentals while South Africa continues to face the depressing economic conditions. This clearly indicates that the global economic activity has been fairly slowed down and is expected to stay so for the coming 2 quarters as most of the emerging and advanced economies struggle to provide growth impetus.

The air freight and the container throughput have shown increasing trends indicative of strengthening global demand. Crude prices fell to a five month low in early May on higher output from Canada and the US, and remain soft, undermining the OPEC‟s recent efforts to tighten the market by trimming supply. These developments suggest that the inflation outlook is still relatively benign for AEs and EMEs alike.

GLOBAL MONETARY POLICY STANCE:

Since late June central banks of developed markets have suddenly started echoing calls for a sooner-than-anticipated normalization of policy on the back of solid growth despite sluggish inflation.

After Fed’s 25bps of rate hike in June, Bank of Canada has already followed by hiking the policy rate by 25bps, the first hike in 7 years. Meanwhile ECB and BoE, although for different reasons, have also been sounding hawkish. The coordinated policy statements led to a sharp reversal in sentiments, resulting in bear steepening of the yield curves across US and Europe. Japan remains the odd one out, given BoJ’s recent fixed rate bond intervention in order to reinforce its commitment towards massive monetary accommodation. However, lately we have witnessed some reversal in earlier tight rhetoric from Fed members, lack of hawkishness in Fed Chair Janet Yellen’s testimony and some ECB members playing down earlier hawkish comments by ECB’s Mario Draghi.

INFLATION OUTLOOK:

On the domestic front, the recent CPI inflation print of 1.54 per cent is significantly lower than RBI’s already downward revised range of 2-3.5 per cent for first half of FY2018. With another print expected to be a tad below 2 per cent (despite inclusion of 7CPC HRA component), and the sustenance of low food inflation in the pre-monsoon summer months is expected to provide comfort to RBI that at least part of the food disinflation is structural in nature.

The forecast of a favourable monsoon further bodes well for food inflation. Also, the refined core index – core excluding petrol, diesel, gold and silver – a metrics of real underlying price pressures, continues to inch lower, suggesting a slower narrowing of output gap than probably anticipated by RBI.  Overall, given the not-so-adverse global environment and benign inflation trajectory, it will be very difficult for RBI to provide a rationale for not easing in the upcoming policy. The headline inflation is likely to stay at sub-4 per cent till November 2017. Undoubtedly, the June inflation reading marks the trough and we thereafter expect a gradual uptrend through rest of the year. In 2HFY18, inflation may largely range between 3.3-4.5 percentage, mostly in line with MPC’s projections.

GROWTH OUTLOOK:

On the growth front, Index of Industrial Production has shown clear signs of stagnancy so far at 1.7% and the central bank has forecasted that the IIP index may further slow down in the next 2 quarters. Also, the Q1 earnings of most companies have not been satisfactory as compared to the inflated valuations of the markets lately. With IIP slowing down, it might act as a key parameter in deciding the policy actions this time.

BANKING SECTOR:

The banking sector has been facing turmoil because of the rising NPA’s and reduction in the overall increase in the exposures. The public sector banks have seen a sluggish credit growth of 7.26% whereas the private sector banks are clocking a fairly good credit growth rate of 17%. This trend is not new for India although, the public sector lenders have been defensive lately due to increasing bad loans. However, RBI might take some new actions in terms of forcing the public sector lenders to create sophisticated systems in order to perform an efficient credit and risk management and simultaneously clean up the balance sheets. With the probability to reduce interest rates in August 2017, the lingering fear of banks shifting their focus to credit growth from balance sheet clean ups shall continue to persist.

With the average inflation almost close to the comfortable levels of 3%, sluggish demand and higher industrial growth, RBI and the MPC would would closely watch the inflation trends in the near future. However, certain additional structural reforms in order to help banks clean up their NPA loaded balance sheets can be expected.  

I predict, that the RBI will cut the repo rates by 25 bps to 6% from the current rate of 6.25% in order to foster growth, IIP and the sentiments. CRR and SLR will be untouched due to the ample amount of liquidity and money supply in the system. The RBI would also like to ensure that the economy’s ERI  of 1% at least which is currently higher at 1.75%.

However, the forward guidance of the policy will continue to be fairly dovish, reform-driven and a certain push towards a more efficient monetary policy transformation. Although, the MPC will have to ensure that the rate cut does not impact negatively on the ongoing balance sheet clean ups and insolvency declarations with an expansionary policy action this month.

Counters are welcome. Thank you 🙂

Advertisements

One Nation, One Tax- Yay or Nay?

The NDA Govt – as part of the most prominent reform since Independence – rolled out the much awaited Goods & Services Tax reforms on the 1st of July, 2017. In this blog, we will understand why GST could not be the uniform tax NDA Govt was aiming for, we will also access the impact of the GST, how will it affect your pocket, the likely challenges the assesses will face while filing the GST taxes which is termed as “The Tax Maze” and ultimately what stocks should you look out for to plan your personal investment decisions.

What was the current problem Indian economy was facing? For consumers, India’s GST is one tax in the most practical sense that currently a bar of soap costs, theoretically, 29 different prices across 29 different states due to 29 different state VATs. Under the GST regime, there’s just one GST rate for a bar of soap. Where India differs from other countries that have implemented GST is that there isn’t one single rate that applies to all goods or services. For example, in Singapore, the tax levied on a pair of shoes and the tax levied on a bar of soap is the same – 7%.

Here’s a quick comparison of rate structure in India as compared to a few selected countries who have successfully implemented GST earlier.

Country Tax Rate
India 5%, 12%, 18%, 28%
Singapore 7%
Malaysia 6%
New Zealand 15%
Aruba 1.5%
Brazil 7%, 12%
Germany 19%

However, the one nation one tax regime was not quiet achieved as the NDA Govt had to factor in the fact that the poor were to be protected from the high rates & a set of political considerations which includes vote bank. In India, the GST council has come out with a rather unwieldy four-rate structure: 5%, 12%, 18% and 28%. In addition to this, there is the exempt category (0%) and additional cesses that are charged on top of certain products, which makes our GST regime have seven effective tax rate slabs.

What will be the macroeconomic impact of the GST rate structure?

 

The impact of GST was anticipated to provide an increase in the GDP growth rate by close to 2-3% provided the GST tax structure was comprehensive. However, witnessing a significantly complicated structure as ours, I suspect that the the GDP growth would not be more than 0.5-1% as compared to the current growth rates. The reason being the complexity of multiple tax rates and continuation of the various exemptions.

A recent analysis by HSBC shows that the roll out of GST is likely to add only 0.4% to GDP, “lower than earlier estimates as multiple tax rates and exemptions announced… are far from an ideal structure and could blunt the growth impact of the reform process.”

Sectoral Impact?

The GST benefit to a certain sector depends on the following two factors:

  1. The actual rate of taxation
  2. The extent to which the operating costs of a particular sector are eligible for the input credit

If a particular sector has higher tax rates but has significant amount of the input credits, the sector shall actually reap the benefits of lower operating costs.

Following is quick synopsis of the critical sectors and the likely impacts:
Capture

Filings Maze!

Businesses will have to undertake 37 annual filings (three a month plus an annual return) for each state the firm operates in. The basic problems for most small and informal businesses are similar: operating costs are about to go up as business owners hire accountants and computerise their operations. Anecdotal reports show that small firms with revenues of below Rs 1 crore could have 20% to 40% of their existing profits go towards GST compliance costs and higher tax rates. Thus, the overall operational costs might push the overall profitability southwards in the medium term. However, once the processes are streamlined, the growth rates might increase but the improvement comes with a significant gestation period.

Joblessness?

GST is deemed to be a bridge to convert the unorganized sector into an organized form. However, it’s largely unclear at this point what extent of small businesses will simply become unviable post-GST. A recent report is not optimistic on what the new GST regime will do for job creation. We note that unorganised sector employs a majority of the labour force. With the unorganised sector shifting to the organised sector, a significant labour absorption capacity that currently exists may get eroded. This can compound the already chronic problem of job creation in India.

Markets Trajectory?

The stock markets have advanced significantly and have taken a positive cue from the fairly smooth roll out of the GST reforms. There were 2 advancing stocks for each decline in the markets for the week so far. However, the markets are expected to be jittery in the medium term as the turmoil regarding the GST filings and the infrastructure glitches.

The markets are expected to drop to the 9400 levels due to corrections. However, the technical indicators of Fibonacci extensions suggest that if the Nifty crosses the 9706 mark, the markets will turn bullish in the medium term. The data currently suggests that the markets are overpriced. Here are my picks for a medium term investment goal to watch out for on corrections:

Capture

What does it mean for YOU as a consumer?

  • Day-to-day essentials are largely exempt from GST
  • Banking and telecom services will get more expensive
  • Eating out to be cheaper if you eat at a non-air conditioned restaurant
  • Luxury cars, which will get cheaper
  • Movie tickets, especially regional cinemas, will get more expensive
  • FMCG products will be cheaper

Anti-profiteering

For instance, soaps and toothpaste are supposed to get cheaper after the rollout of GST. They currently have an effective tax rate of 24-25% and after GST, this will come down to 18%. However, if as a consumer, you have always been paying say Rs 75 for a tube of toothpaste, it’s highly unlikely that the company that sells you the toothpaste or bar of soap will make it cheaper once you’ve gotten used to paying Rs 75.

To solve this potential problem, the GST legal framework creates an “anti-profiteering authority” that will check whether businesses are passing on the benefits of the new tax regime to consumers. Legal experts and industry leaders have almost unanimously declared that this anti-profiteering body will spark a minefield of litigation and prove to be problematic.

Conclusion

GST roll out on time and with ‘just enough’ infrastructure is a bold move by the NDA Govt. I do agree with the fact that the awareness approach could have been better. On a consolidated basis, the end consumer may not be the most benefiting entity in the economy. The businesses will be definitely benefited from the GST structure. However, there are a few aspects where the NDA Govt must act in the coming years. Once stabilized, the NDA Govt must try and unify the existing 4 rates as the economy starts witnessing the long term benefits of the GST regime.

Thank you. 🙂

Opinions and counters are encouraged!

Loans – Why One MUST Shift From Base Rate to MCLR?

Loans have been a cause of concern for most of the middle class and higher middle-class population due to the significantly higher real estate rates. The repo rates have reduced quite significantly in the past one year. However, the benefits of such reduction seem to reach the borrowers with a hair cut. Until demonetization, the loan rates have been hovering above 10% levels. However, now with the base rates reducing, with every rate cut, there is an additional benefit for the borrowers. Here’s how.

With demonetization, the overall deposits have increased significantly leading to an excess liquidity situation in the banking sector. This has compelled the banks to lower their lending rates across various tenors. Banks have been under immense stress in terms of the NIIs and NIM margins lately due to the sudden inflow of deposits. However, this seems to be a good news for the borrowers. Although, the corporates will still continue to be priced basis the overall indebtedness and may not be benefitted by the interest reduction. The individuals, on the other hand, will be immensely rewarded by the existing interest rate regime.

Currently, the interest rates are pegged to something called as a base rate. Now the base rate does change with the repo rate, but the change is reflected with a lag of at least 6 months despite the RBI’s efforts in increasing the overall monetary policy transmission. RBI has now announced that the banks shall move from a base rate system of cost of funds to something called as MCLR (which is affected by the repo rate movement as well as the deposits). What must the borrower do?

  1. Check the outstanding and the tenor of the loan. If the outstanding is less than Rs 5 lacs or the loan tenor is less than 3 years then one should not shift to the MCLR regime. If only otherwise, then one should shift to MCLR regime at the earliest looking at the downward bias of the repo rates.
  2. Contact your bank and ask them to link your home loan rate with MCLR instead of the base rate. The customer will have to pay a one-time charge of 0.5% of the total outstanding amount of the loan or one can get it done for free on the date of the anniversary of the loan.
  3. From there on, one will have two options, EMI reduction or tenor reduction. It is always advisable to choose the latter.

Why is it so important to align your rates with MCLR? As we know, the RBI has reduced the repo rate by almost 150 bps in the past fiscal year. The benefit given to the borrower of the reduction is in the range of 25-35 bps on the base rate, whereas the benefit if shifted to MCLR is up to 90 bps which would save almost 2 lacs over a total outstanding of Rs 50 lacs over the entire tenor. Hope that helps in understanding the rationale to shift the paradigm from base rate to MCLR. Demand for the MCLR linked loans, the transparency is way higher than the base rate ones.

Below is a quick understanding of the amount of savings one can make by shifting the loans to MCLR.

20161020_switch-from-base-rate-to-mclr-calculations-2

Another benefit of shifting to MCLR interest regime is with every rate cut the eligibility limit of the borrower increases significantly, especially for the ones where residual tenor is 10 + years. A borrower earning Rs 1 lac a month is eligible for Rs 55 lacs of home loan for 20 years. The same individual can now get a 60 lacs loan for the same tenor. The eligibility limits increases to Rs 62 lacs for a 25-year loan tenor. Although the pricing of the loan is subject to the customer’s overall risk grading, one can definitely shift to the MCLR pricing owing to the downward bias of the interest rates.

One must always keep in mind, if the EMI is reduced, then one gets equated benefits over the months, whereas if the tenor is reduced instead of the EMI then the benefits are received by the end of the tenor which would essentially will be lump- sum and most definitely higher than the former approach. However, you should take a call basis the current cash positions and appetite to bear the EMI amount.

Thank you. 🙂

 

 

 

 

 

Demonetization – NDA’s Smart Move Towards Dismantling The Parallel Economy

On the 9th of Nov, 2016, the NDA Govt came out with an announcement of the discontinuation of the Rs 500 and 1000 currency notes. The news created great discomfort and unrest amongst the people. The move was in the wake of increasing black money and counterfeit notes in circulation. The topic is of immense interest since this move is going to impact the several sectors of the economy and the way policy decisions are approached. I would like to bring out the overall meaning of the parallel economy, the causes, the key commodities which lead to the creation of the parallel economy, the cost that RBI will have to bear because of the decision and further a set of comments on the cost-benefit analysis of the decision from a central bank perspective in this blog. In addition to the above, I would also like to bring out the effects of the Govt’s decision on the near future RBI Monetary policies in the context of the rate and the liquidity, the likely near-term effects on the stock markets, liquidity management of the banks, the effects on real estate, MFIs etc. Let us look at the overall situation and a quick impact analysis on the same.

The parallel economy has been a critical pain point for the NDA Govt to function smoothly. A Parallel economy, based on the black money or unaccounted money, is a big menace to the Indian economy. It is also a cause of big loss in the tax revenues for the government. The Indian economy has grown by 30% in the last 5 years whereas the high value denominated notes have gone up by around 90%. This essentially indicates that the transactions which take place are largely in cash and are unaccounted for and that eventually leads to a creation of a parallel economy and all such transactions do not contribute to the net GDP thus creating hindrances to the growth rate. In order to take a stance against this, the NDA Govt decided to discontinue the old currency notes and replace them with new so that the parallel economy transactions reduce significantly or might come to a stand still in a bit.

Key cause of Parallel economy creation:

  1. Tax Evasion
  2. Cash transaction in trade and services
  3. Corruption
  4. Equity market manipulations
  5. Real Estate etc

Key Investment Avenues for such lump sum cash:

  1. Gold
  2. Informal lending/deposit market
  3. Real Estate

 

Effects on the Monetary Policy:

The Reserve Bank of India may have to change the policy course amidst removal of high value notes as the huge accretion in deposits will increase the overall liquidity in the system. In this situation, the RBI might have to sell out bonds to suck the additional liquidity in the system. The high liquidity in the system shall lead to cheaper loans thus boosting inorganic growth. RBI may want to minimize such impact if any. The additional CASA deposits shall lead to low rate deposits thus leading to cheaper lending with a lagging effect of about 2 quarters.

Sectoral Effects on the Economy:

  1. Real Estate – With lower interest rates in the near future and a liquidity crunch in the real estate sector, home prices might come down by about 20-25% in the medium term.
  2. E Commerce – Reduction in cash transactions has already forced amazon and flipkart to discontinue their cash on delivery services thus impacting their reach and business in terms of the overall sales.
  3. Infrastructure – The sector might face immediate heat since most of the payments to the labourers are made in cash
  4. Agriculture – Agri might face immense negative impacts since the trade largely is carried out on cash basis including the purchase of seeds and fertilizers. However, the impact will be short-lived.
  5. Housing Finance Companies – Sector finance companies shall have opportunities for higher demand amidst lower home prices. However, it might face the heat in terms of the overall credit quality where the lending has been largely for low-income groups.
  6. Banking – Banks/NBFCs shall be benefitted since a large sum of low-cost deposits in the form of CASA accounts shall be accumulated. However, liquidity management and efficient operations shall continue to pose challenges to the banking institution at least till December.

Market Outlook:

The markets shall continue to be volatile in the short-term and significantly jittery in the medium term. The markets are yet to price in the effects of the sudden decision but we can the markets to neutralize by the end of the month. However, the long-term outlook shall be bullish as far the demonetization impacts are concerns. Ultimately, the markets will take their own course based on the likeliness of the future events. Nifty should rise back to the 8500 levels by November end is the majority consensus so far.

Cost Benefit of De-monetization (RBI Perspective):

fullscreen-capture-11122016-60702-pm-bmp
Total Cost of Printing Vs Demonetization Benefit Comparison

What the above numbers mean is that the cost for RBI to print new notes shall be close to Rs 62 Billion. The Govt, on the other hand, has targeted to demonetize around 170 Billion. Assuming 100% success, the Govt shall be demonetizing close to 170 billion which is as good as three times the cost the Reserve Bank shall bear to make a smooth transition. It largely is a benefittin trade-off for the Govt as well as the RBI.

The decision of the NDA Govt is one of the most prominent moves of the decade towards making India a better country in terms of growth and transparency . However, the approach of the Govt in handling this chaotic situation smartly will drive the near future results. The Reserve Bank on the other hand, will have to make sure they keep mopping up the additional liquidity in the system and intervene when required to ensure the financial stability of the system. India has clearly welcomed this decision as far as the reactions all over are to be considered. It will be challenging to see the handling of the outcomes that evolve from the decision taken. Hopefully, this should be the fresh start towards making India a more transparent, efficient and the fastest growing emerging economy. If not complete eradication, this will definitely reduce the overall impact of the parallel economy and transfer the reduction as a contribution to the real economy growth rate. I hope as citizen, we will make an effort to ensure the new notes being printed are not soiled by writing on them or keeping them in unhygenic conditions as it adds huge cost to the Govt and the Reserve Bank.

I would love to know the diverse views of the readers as well. Thank you. :).

 

 

Monetary Policy Review – Urjit Patel’s and MPC’s First

The Reserve Bank of India will announce its fourth bi-monthly monetary policy for the year on Oct 4,2016. This policy review shall be the first one for the incoming Guv Urjit Patel and the newly formed Monetary Policy Committee . Will it be a rate cut, a status quo or a rate hike in anticipation to the current economic and global conditions? Let us take a glimpse at the domestic conditions and the global economic conditions as well to assess the probable outcome of the monetary policy on the coming Tuesday. We will discuss the current scheme of things with the monetary policy, various domestic parameters, monetary policy transmissions – improvements and finally what would be the outcome of the monetary policy this time. It would be interesting to see if Dr. Patel would do a Rajan 2.0.

This review shall be a special one as the outlook shall be decided by a committee formed collaboratively by the RBI and the Government. The MPC aims to provide greater transparency to monetary policy while taking the onus of interest rate decisions away from the sole purview of the RBI governor. The committee comprises of 3 representatives from the Government (who are typically veteran economists) and 3 members from the RBI including the Governor. However, the chairman of the committee shall be the Guv himself but the overall decision making of the policy rates shall be taken as a committee decision.

The current scenario of the policy rates is as follows:

  1. Repo Rate – 6.5%
  2. Reverse Repo – 6% (Being pegged at 50 bps to the repo rate from the last policy review since the volatility of the call rates has significantly reduced)
  3. Marginal Standing Facility – 7.00 % (Being pegged at 50 bps to the repo rate from the last policy review since the volatility of the call rates has significantly reduced)

On the global front, most central banks have maintained their status quo although a few of them have reduced the deposit rates in order to reduce the cost of funding. The Federal Reserves stays put to their stance of status quo and is not expected to step on the gas until further significant recovery signals. On the domestic front, the CPI inflation rate has inched up significantly for the past two months leading to a higher average for the period. Food inflation, being one of the critical pain points for the Indian economy, has softened significantly due to near normal rainfalls and supply side management from the Govt’s end. The collaborative effort has fairly allowed the food inflation to be tamed at comfort levels. Let us take a quick view at all the other domestic and global factors to be considered for the monetary policy review.

Headline inflation rate (CPI), has stepped southwards and is expected to be at the levels of around 5 % in the near future because of the steady and near normal rainfall this year. The sustainability of the rates staying in the desired corridor depends on an efficient supply side management from the Govt. This year, the rainfall deficit has only been 3% compared to the normal rainfall levels. The 91 important reservoirs of the country, which have efficient irrigating abilities are 97% of their maximum capacity, essentially suggesting that if used appropriately might turn out to be a game changer for the produce this year, thus reducing the overall food inflation. The food inflation , on the other hand, has dropped noticeably at 6 % levels from about 9% levels. Thanks to the fairly efficient supply side management. Below is the overall CPI inflation rates and food inflation rates:

cpicpi_1

The food inflation as well as the CPI inflation look quite stable and at comfortable levels and are expected to head southwards in the near future as well. But, with the festive season coming, the inflation might inch northwards sharply despite the ample supply. This might create a hindrance for a rate cut case. With the auto-regressive integrated moving average predicted forward curve shows a probable uptick in the inflation rates as shown below. RBI would want to wait and watch for the inflation numbers to be published in the next cycle before they create a case for a rate cut.

On the growth rate front, the IIP index has been in the negative areas for the past 2 months. However, the core growth metrics suggested otherwise for the current cycle. The core growth consists of growth rates of 8 prominent industries which contribute to about 38% of the IIP rates. The core growth rate has been significantly good at 3.2% which might help the IIP to be at a higher level. Although, the growth rates look dampened, they are expected to inch upwards due to higher demand and stable inflation rates. Here is the IIP trend so far and expectations:

iip

In the case of IIP as well, the RBI would like to wait until there is another expectation of an IIP % drop.

The banking sector has been facing turmoil because of the rising NPA’s and reduction in the overall increase in the exposures. The public sector banks have seen a sluggish credit growth of 9.26% whereas the private sector banks are clocking a fairly good credit growth rate of 20%. This trend is not new for India although, the public sector lenders have been defensive lately due to increasing bad loans. However, RBI might take some new actions in terms of forcing the public sector lenders to create sophisticated systems in order to perform an efficient credit and risk management and simultaneously clean up the balance sheets. RBI might not choose to use the repo rate route as of now since this is clearly a situation of fear regarding the rising bad loans more than the sluggish demand.

loan-growth

The call money rates/IBLR has been stable lately due to the efficient liquidity management by the RBI. The call rates are however expected to head downwards although at a decreasing rate since there is enough liquidity in the system in order to sustain sudden spikes. Here’s a quick view on how the rates have been so far:

capture

Considering the average CPI at 6% and the repo rates at 6.5%, ERI is hovering around 0.25-0.5%  which might affect the growth in the coming future. Although the ERI is much lower than the RBI comfort zone of 1-1.5%, this might not act as a trigger for a rate cut since taming inflation shall hold priority. However, it does call for a rate cut in December to increase that ERI window to 1% at least. We might expect some action from RBI in December, probably of about 50 bps rate cut.

What does all of this mean for the upcoming monetary policy?

With the average inflation almost close to the uncomforting levels of 6%, sluggish demand and higher industrial growth, RBI and the MPC would want to wait for more data in terms of the inflation trends in the near future. However, certain structural reforms in order to help banks clean up their NPA loaded balance sheets can be expected.  I predict, that the RBI might hold the repo rates at the current levels of 6.5%. CRR and SLR might also be untouched due to the ample amount of liquidity and money supply in the system. But witnessing the current conditions and the forecast, RBI might have to step on the gas in the next review with a rate cut of 25-50 bps in order to ensure that the economy is at a comfortable ERI of 1% at least. However, the tone of the policy would continue to be fairly dovish, reform-driven and a certain push towards a more efficient monetary policy transformation. Also, RBI would want to maintain its accommodative stance and be clear in its long-term focus of creating the credibility that Dr. Rajan has started with. I hope with Dr. Patel’s stance, we might get to see Rajan 2.0.

Thank you. 🙂

 

 

 

 

Third Bi-Monthly Monetary Policy – R3’s Final Move

The Reserve Bank of India, will announce its third bi monthly monetary policy for the year on Aug 9,2016. This policy review shall be the final move from Dr. Rajan (R3 – RaghuRam Rajan) – the man in the hot seat for the past 3 wonderful years. Will it be a rate cut, a status quo or a rate hike in anticipation to the current economic and global conditions? Lets take a glimpse at the domestic conditions and the global economic conditions as well to assess the probable outcome of the monetary policy on the coming Tuesday. We will discuss the current scheme of things with the monetary policy, various domestic parameters, monetary policy transmissions – improvements and finally what would be the outcome of the monetary policy this time.

A quick background of the current stance in terms of the rates – CRR at 4%, SLR at 21%, Repo Rate at 6.5% (stagnant at that stage for quiet a while now) and the rupee has been hovering in the range of 65-67. On the global front, the Federal Reserves have kept their rates unchanged as well for a significant time span. The Bank of England was witness cutting the lending rates from 0.5% to 0.25% last week. Generally, when the interest rates are near zero levels, if a central bank chooses to cut it further, it essentially signals that the growth is stunted and the central bank wishes to spur the same to the extent possible without using any unconventional monetary measures.

A lot has happened since the past 3-4 months – the Brexit and its global effects, the gradually syncing fear of another global meltdown with most of the advances economies unable to exit the recession ill effects. India, although has been stable so far, cannot afford to think yet another time that we are decoupled from the global turmoil. Being emerging nations, we will be affected by the global downturn if the right measures are not in place. The global conditions are signaling a more accommodative and stable monetary stance (which essentially means a status quo).

On the domestic front, the headline inflation has been inching northwards from the past 3 months. This aspect would definitely get Dr. Rajan worried since the inflation targeting regime would be breached in case the inflation keeps increasing with the persistent rates. The CPI inflation has been hovering around 5.5-5.7% levels lately, however the same going anywhere beyond 6% would have an impact on the consumption and demand growth in the near future. With the target of maintaining the average inflation at 4% by Jan 2017, this monetary policy stance should be a status quo. Food inflation, although increasing at a decreasing rate, should essentially provide some relief for the central bank. The rainfall also has been fairly above the average levels compared to the previous 3 years.

With the auto-regressive integrated moving average predicted forward curve shows a probably uptick in the inflation rates as shown below. RBI would want to wait and watch for the inflation numbers to be published on the 12th of August before they create a case for a rate cut.

Fullscreen capture 862016 65938 PM.bmpFullscreen capture 862016 65900 PM.bmp

Wholesale price index which was showing deflationary trends in the previous quarter has now started to head northwards sharply in the past 3 months. As far as the inflation metrics are concerned, it certainly reemphasizes a status quo in this monetary policy review.

On the growth front, Index of Industrial Production has shown clear signs of stagnancy so far, but the central bank seems to be hopeful about the revival in the next two quarters since the rate cuts will kick in with a lag. However, the Q2 earnings of most companies have been satisfactory amidst such global turmoil in the rest of the advanced economies. With IIP slowing down, it might act as a key parameter in deciding the policy actions this time. The downward trend however indicates a case for a 25bps rate cut sometime before the end of 2016. Here’s a quick look at the IIP and the forecast so far:

Fullscreen capture 862016 70111 PM.bmp

The currency markets being in turmoil, the rupee has managed to perform significantly better than the rest of the emerging economies, especially against the dollar. I feel, the RBI has create significant foreign currency reserves in order to deal with the turmoil in a much robust way that ever before. With no requirement to stabilize the currency from policy actions, it indicates a status quo as well.

Banking sector, however, has been still struggling with the asset quality. The loan growth still is unable to surpass the barrier of 12% levels, whereas the deposit growth stands at 11%. However, we must appreciate the fact that the inflation targeting regime has been managed efficiently and the loan growth rate has been taken care of simultaneously as well. Although, the loan growth seems subdued, RBI still has room to take hits on the same for a few more months and wait for the global unrest to stabilize. A quick glimpse at the loan growth will indicate the improvements and the forecasts as well:

Fullscreen capture 862016 70158 PM.bmp

The call money markets and the inter bank lending rates have shown a fairly stable nature. The indication of stability of these rates is when they do not break the 200 bps window created by the RBI by setting the repo rates. For the readers: Repo rate is at 6.5%, in order to conclude that the call money rates are stable, they need to be between the 6% (Current Reverse Repo Rate) and 7.0% (Current MSF rates/ Bank Rate) corridor. This corridor usually used to be 200 bps when the liquidity conditions were tight. In case, they break either levels, it calls for a interest rate action to accommodate the change. The current scenario indicates that there is absolutely enough liquidity in the system and no action whatsoever is required by the central bank via the monetary policy tools. A quick glance at the IBLR and its forecast:

Fullscreen capture 862016 70237 PM.bmp

Inefficient monetary policy transmission has been creating hindrances for RBI from a year now in terms of passing on the benefit to the customers. The RBI has reduced the repo rate by over 125bps yet the banks seem to have passed on the rate cuts only to the tune of 60-70 bps. The reason being, the stressed assets and the intense pressure on profitability due to increasing costs and provisions. In order to address this, the RBI asked the banks recently this year to shift their calculations of cost of funds to a efficient method called as the marginal cost of funding. Since then, the banks have implemented the same and a few of them have managed to pass on the benefit of another 5-10 bps recently. Although, the results have been evident, the transmission is going to be a key concern for the RBI in the coming period as well.

Considering the average CPI at 6% and the repo rates at 6.5%, ERI is hovering around 0.25-0.5%  which might affect the growth in the coming future. Although, the ERI is much lower than the RBI comfort zone of 1-1.5%, this might not act as a trigger for a rate cut since taming inflation shall hold priority. However, it does call for a rate cut sometime this year to increase that ERI window to 1% at least.

To sum up, the domestic conditions for growth are improving gradually, mainly driven by consumption demand, which is expected to strengthen with a above average monsoon and the implementation of the Seventh Pay Commission award. Higher public sector capital expenditure, led by roads and railways, should crowd in private investment, offsetting somewhat the subdued requirement for fresh private investment due to financial stress. Yet, business confidence will be restrained to an extent on account of uncertain global factors for the next 6 months at least.

What does all of this mean for the upcoming monetary policy?

It is needless to say that the global economy is under significant pressure. Certainly, the solution does not seem to lie in the monetary sphere at the current moment. I predict, that the RBI might hold the repo rates at the current levels of 6.5%. CRR and SLR might also be untouched due to the ample amount of liquidity and money supply in the system. But witnessing the current conditions and the forecast, RBI might have to step on the gas in the next review with a rate cut of 25 bps. However, the tone of the policy would continue to be fairly dovish and reform driven. However, RBI shall continue to keep its inflation targeting focused until it is tamed to a consistent 4% levels by 2017.

Thank you. 🙂