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.


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):

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:


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:


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.


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:


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:

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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. 🙂

When The Acche Din Were Around The Corner…

When the acche din were just around the corner, here are two big events that have occurred in the past two weeks (Brexit and Rexit). I would like to talk about brexit in one of my other blogs, and would be focusing on Rexit ( Dr. Rajan opting out of the second term as the RBI Governor) in this one. Raghuram Rajan will step down as the 23rd governor of the Reserve Bank of India when his term expires on 4 September,2016. In this blog, I would be giving in sense of his achievements post his appointment as the RBI Guv, the likely impacts on the markets due to REXIT and the next likely predecessors for the position of the RBI Guv. I will also share statistics in terms of the key indicators before and after Dr. Rajan took over on the Sept 4, 2013.

From converting the Reserve Bank of India into an inflation targeting central bank to forcing a long overdue clean up of the banking sector, Rajan’s three year term has created significant progress. Dr. Rajan, has always been a inflation targeting Guv since the belief was strong that neither higher inflation nor lower interest rates are going to boost growth solely, the growth is always a mix and balance of the two parameters. With his highly focused regime of concentrating on the monetary aspects of the economy by considering various external and internal events has been effective in all the possible ways.

Here’s a list of the key improvements/actions/achievement by the veteran:

  1. MPC (Monetary Policy Committee) – Dr. Rajan announced a committee to review the monetary policy. Although, the attempt was then tweaked by the Govt in such a way that currently there is a hint of RBI Guv losing his rights to take the final decision on the policy actions.
  2. Inflation Targeting – Right after taking over as the governor, Raghuram Rajan appointed a committee to review the monetary policy framework. The committee recommended that the RBI formally shifts its focus on to the consumer price inflation index as the nominal anchor for monetary policy in the country rather than WPI. As part of this framework, the RBI was to bring down inflation to 6% by March 2016 and 5% by March 2015. Over the medium term, the RBI now has a target of bringing inflation down to 4% (+/- 2%). Looking at the current situations, the RBI has fairly achieved its targets.
  3. Revitalization Stress Assets – RBI took various measures against the stressed assets of the banking sector especially in terms of the corporate and strategic debt restructuring norms.
  4. Bank Licensing – While the process of licensing another round of universal banks was kicked off during D. Subbarao’s tenure, Rajan’s tenure saw two new banks (IDFC Bank and Bandhan Bank) being licensed. The more significant step in this context, however, was the licensing of differentiated banking licenses.  11 payment banks were given an in-principle approval and at least eight of them will launch operations by early next year to increase penetration in the rural economy. In addition, ten small finance banks were also given in-principle licences to serve small borrowers and businesses. Rajan also floated the idea of wholesale banks and custodian banks, although, with no guidelines as of now. The RBI put out a draft framework for on-tap universal bank licensing as well.
  5. 5/25 Scheme – RBI allowed corporate to extend tenors of credit in case of infrastructure projects thus providing them with a higher gestation period.
  6. Market Development – Market development has been top of the agenda for Rajan as well. The RBI, under Rajan, has also for the first time put in place a framework for foreign investor participation in the bond markets. The RBI may start accepting corporate bonds as collateral for its liquidity operations.
  7. Repo Rates Decline – Repo rates were brought down to 6.5% ( Lowest in the past 6 years) with inflation targeting as the key focus.

Apart from the above mentioned monetary measures taken, Dr. Rajan’s timely actions on the monetary policy decision has enabled a huge change in the key macro economic indicators of India before and after Dr. Rajan taking over. There has been a huge difference in the numbers including the credibility in the world economy and the reduction in the instability of the economy. Here’s a quick stat on that:

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Although, it was an extremely surprising decision by Dr. Rajan, it was very well anticipated looking at the tension between the RBI and the Govt in the recent past. The markets have reacted negatively because of the sudden decision to not continue. The short-term blip will continue for the next 3 months and might settle down once the monetary front is stabilized post appointment of a new RBI governor. However, markets will keep dipping in the short term amidst the uncertainty on the global front, whereas the medium and long-term trend look significantly bullish.

Who Will Fill Rajan’s Shoes:

Lets look at behind-the-scenes scenario of how the RBI Governors have been appointed till date. Even though the Appointments Committee is the official vehicle to do the job, typically, the Prime Minister’s Office chooses the governor with inputs from the finance ministry and the outgoing governor and, on most occasions, there is no written recommendation. The politicians of the ruling party play an important role in the selection but the corporate houses that normally try to influence the appointment of CEOs of commercial banks do not have a voice here, although they have their own preferences.

Here are some of the options that the government may consider as it searches for the 24th governor of the RBI. The four likely candidates are: the current RBI Deputy Governor Urjit Patel, former deputy governors Rakesh Mohan and Subir Gokarn, and State Bank of India Chair, Arundhati Bhattacharya.

Here’s our quick analysis on who would be the probably choice of the Govt:

  1. Rakesh Mohan – A former Dy Guv and a veteran economist. Logically, he will be apt for a fiscal role rather than a monetary chair role due to experience in the former. However, politically he might stand a chance in case the Govt is looking for an economics reforms expert to head the RBI.
  2. Subir Gokarn – A former Dy Guv and a veteran economist especially in the areas of food inflation and inflation related research. However, he might not be the right candidate to head the RBI since that would require the expertise and experience on handling the monetary front of an economy.
  3. Arundhati Bhattacharya –  A career banker, Bhattacharya may make a good candidate against the bad loan crisis in the banking sector. The trouble with appointing Bhattacharya as the head of the central bank is that there is no precedent in recent times of a banker being appointed as the RBI governor. While one of the four RBI deputy governor’s is always a senior banker, the central bank chief has typically been someone who has had an understanding of the wider economy.
  4. Urjit Patel – Current Dy Guv of the RBI. Urjit Patel, who chaired the committee on a new monetary policy framework, has overseen the RBI’s transition to an inflation targeting central bank. Patel has also been driving the central bank’s liquidity policy as well. According to me, Urjit Patel has the highest probability to be appointed as the next Guv of the RBI. However, the political front of the appointment may be different from the predictions that are logically sound.

To sum up, India was in deep trouble in terms of macro economic indicators and the stability of the economy. Dr. Raghuram Rajan, took over on 4th Sept, 2013 and changed the overall image and credibility of the economy. However, it is a sad event that he choose to return back to academia from being the dashing RBI Guv. Although, he has made his choice to join academia, he will always be remembered as the youngest and the most respected Guv of RBI in the coming years. It will be difficult for any other veteran to fill in his shoes, but however, Urjit Patel and Arundhati Bhattacharya look to be the probable candidates to head the RBI so far. When the acche din were around the corner, its hard to believe that Dr. Rajan has quit. 

Thank you. 🙂







Run Up to the 6th Bi – Monthly Monetary Policy

The Reserve Bank of India, will announce its first bi monthly monetary policy of the year on Feb 2,2016. It will be interesting to see Dr. Rajan’s decision on the policy rates. Will it be a rate cut, a status quo or a rate hike in anticipation to the current economic and global conditions? Lets analyse based on a set of parameters and global economic scenario. In this blog, we will take a quick look at the macro economic indicators of inflation, growth and financial stability. We will also access the global conditions in relation to such relevant parameters. Currently, the repo rate is 6.75%, CRR fairly steady at 4% and SLR at a reasonable lower levels of 21.5% compared to the year 2013.

Recently, in its last monetary policy, the Federal Reserves decided to raise its interest rates after 7 consecutive years of near zero interest rates. Although, the decision was anticipated, the effects of the same will be felt by the global economy in terms of further slowdown. The rise in the fed rates, will be something significant for the RBI to consider before it takes any action in the sixth bi-monthly monetary policy.

The RBI in its policies so far, has been easing the policy stance from Jan 2015 with the intention of fostering growth of the real economy. RBI till its fifth monetary policy statement was quiet positive on the growth especially with a hint of an uptick in the manufacturing sector. With that hope, it had also kept its GDP expectations unchanged in its previous review. However, much has changed since then. The Indian economy has slowed down sharply towards the end of 2015. 

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With the growth slowing down in the coming quarters, RBI might re-look at its estimates in the upcoming monetary policy. Index of Industrial production has reduced from the 5% levels of July-August quarter down to 3.5% in the Sept-Nov. IIP in Nov has shown a sharp decline Month On Month with the manufacturing sector and infrastructure slowing down. PMI indices of manufacturing and services have also indicated a reasonable amount of contraction, for the RBI to worry about. 

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The inflation scenario, too, has started worsening from the past 5 months. While the headline CPI inflation is headed northwards with an uptick in the food inflation and core inflation figures. The food inflation might further intensify in the coming months the constant stress on agricultural produce due to back to back droughts, unseasonal rains and relatively warmer winter impacting the rabi crops. On the fiscal front, the indication of a seventh pay commission and the further implementation of the same in the upcoming budget might add to the inflation further. However, these effects will be transitional rather than structural. With CPI inching upwards, WPI has shown an increase as well. Although, WPI is still suggesting deflation, the rate of deflation has sharply slowed down from the past 3 months. 

Note for the readers: Food inflation and core inflation form the basics of the CPI inflation figures in India. While the food inflation indicates the inflation of food items such as vegetables, pulses, fruits, milk,eggs etc, the core inflation indicates the inflation related to non food and non fuel items.

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Food Inflation
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On the banking front, RBI has been facing issues in the implementation of effective monetary policy transmissions. Despite RBI reducing the repo rates to the tune of 125 bps, bank’s base rate have reduces only by 55-60 bps. Apart from that, the pressures of non performing assets are mounting. However, the new base rate formula calculation might act as a catalyst towards the reduction in the base rate. In addition to the current scenarios, the deposit growth has been at par with credit growth which is a relief to the RBI so far. The credit growth has picked up lately as the lagging effects of the policy easing.

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Credit Growth Trend
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Average Base Rate

Currency markets have been highly volatile lately, in the wake of unrest in the major global players. Rupee has been sloping downwards compared to the dollar in the past six month. Dr. Rajan has however managed to control that volatility by selling millions of dollars in Oct-Dec quarter. RBI would atleast not reduce its interest rates in the near future, in order to stop the rupee from sliding further. However, the good part is rupee has performed extremely well in comparison to the other emerging economies. Considering the CPI at 6% and the repo rates at 6.75%, ERI is hovering around 0.75-1% which might affect the growth in the coming future. However, RBI would still be focusing on reducing the inflation and retaining the financial stability before any further easing. On the global front, RBI would want to keep its stance as is and be a star performer in contributing to the global growth compared to the other economies. India, might grow at close to 7-7.2% this fiscal year look at the current conditions. Due to the interest rate hike, the FPIs have pulled out more than 9500 Cr from the Indian equities on global worries. That has undoubtedly led to ongoing volatility in the Indian financial markets. 

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

There is no doubt that economic slowdown has become acute in the recent month. But the same has happened despite significant easing from Jan 2015. Certainly, the solution does not seem to lie in the monetary sphere this time. I predict, that the RBI might hold the repo rates at the current levels of 6.75%.CRR and SLR might also be untouched due to the ample amount of liquidity and money supply in the system. However, the tone of the policy would continue to be fairly dovish . The RBI might re-look at the GDP forecast and reduce it from the current forecast of 7.4% to 7-7.2%. However, RBI will keep its consistent focus on the inflation control and financial stability goals by maintaining an orderly depreciation in the currency and stable interest rates. 

Thank you. 🙂