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. 🙂

Advertisements

Fifth Bi-Monthly Monetary Policy – Likely Outcome

The Reserve Bank of India will be publishing its fifth and probably the last bi monthly monetary policy for the calendar year 2015. The reason of it being “probably” the last is there are chances of Out of Cycle Policy actions if US Federal Reserves decides to increase its interest rates in their next FOMC meeting which will be held on 15-16 Dec, 2015. Although, looking at the current scenario, its is difficult to predict what the FED might decide in the near future. However, I will focus predominantly on domestic factors in this blog to conclude the likely outcome of the monetary policy. 

Here are a few links for the readers to recap on the scenarios of the entire year:

RBI BI-MONTHLY POLICIES

Lets focus on the domestic factors first. Index of Industrial Productions in the past two months has been on the lower side. The surprising slowdown despite rate cuts does call for a rate cut at a macro level, but the impact has been predominantly due to global growth slowdown. CPI on the other hand, increased to 5.14% in Sept while 5% in October. The sudden increase in CPI is due to the prices of pulses increase heavily in this quarter. WPI, so far has been showing a dis-inflationary path but the wide difference in the two indicators is still a problem for the CSO and the RBI in terms of reliability. The two indicators,namely CPI and WPI, are causing an ambiguity in terms of the inflation figures. The divergence between the two has been increasing lately. The image below might explain as to how these indicators are contradicting each other. However, since RBI has been focusing on taming inflation on a priority basis, the focus will be lower on the slowing IIP figures.

Fullscreen capture 11292015 110453 PM.bmp

On the domestic front, the banking sector still seems to fight the rising NPAs. The part that Dr. Rajan would be worried about apart from that is the deposit growth outpacing the credit growth continuously for the past 12 months. The good part of the bad situation is that the gap between two is reducing gradually.  Although, RBI is doing its bit in uplifting the current conditions of the banks by rolling out timely reforms, a robust solution would always be a pickup in the domestic demand. Till that time, I guess RBI’s hand would be tied up for any further actions. Liquidity conditions as well seem to be comfortable with the call money rates fairly stable and well within the repo window which does not call for any further easing in the near future. 

Fullscreen capture 11292015 110334 PM.bmp

On the global front, the slowdown is deepening and might continue to stay subdued in the near future. China is facing immense distress situation. US on the other hand is waiting for the inflation figures to increase to the expected levels so that they can take a call on hiking the rates. Euro Zone as well is struggling to come out of the dis-inflationary path despite the extended quantitative easing. 

Economic condition in terms of reforms does not look great with hurdles for GST passage persistent. On Dec 5th, the Arvind Subramanian committee will give its recommendation for the GST rate. Winter session will decide the course for the growth rate as well as the market conditions for the Indian stock markets. A pickup in the gold monetization scheme will also be a key metric in determining the fiscal condition in the coming year. 

To conclude, with the CPI, WPI and the food inflation rising, IIP reducing slightly, substantial probability of a US FED hike, the RBI in its fifth bi-monthly monetary policy will maintain a status quo in terms of the repo rate(6.75%) and the CRR (4%). SLR on the other hand will be reduced by 25 bps. SLR will be 21.25% from the current levels of 21.5%. The importance will be on the tone of the speech on Tuesday and the same will tentatively signal RBI’s intentions in the near future. With this action, Dr. Rajan might put the ball in the Govt’s court to roll out the necessary reforms to move the economy forward. It will be important for the Govt, RBI and the CSO to also reach a consensus on the inflation indicator for a much clearer picture in terms of the real conditions in the economy. RBI will be closely watching the inflation figures before they decide to do any further easing. 

Thank you.
🙂

A Lot More Than A Century…

The Reserve Bank of India in its monetary policy review surprised the markets with a 50 bps rate cut. A few expectation stood at status quo based on the technical indicators, whereas a few expressed their views as a 25 bps cut. Dr. Rajan ultimately decided to cut rates by 50 bps taking the advantage of the appropriate levels of room given by the lower inflation. The markets and the corporates have welcomed the rate cut. Although, there has been a certain level of transmission loss so far but RBI is hoping for a complete transmission with time. RBI in 2015, has already scored a century with its total of 125 bps rate cut to boost the economy, but the govt seems to struggle to achieve the same. Apart from the surprise rate cut, there was a lot more in this policy on the reforms side of it. In this article, we will take a look at the reforms other than the 50 bps repo cut and discuss in brief about the probable contribution of rate cuts in boosting equity returns.

ReformsAnyone

With almost no signs of reforms from the fiscal policy stance in the form of GST bill passage, RBI has decided to take the initiative in driving the investment. RBI in its recent policy statement has given certain decision, which are expected to drive the investment in India.

Following are the reforms:

  1. Guidelines on Marginal Cost of Funding have been given to banks. RBI has initiated the process of reducing the transmission losses. The banks have been asked to shift from the current system of Average Cost of Funding to a more advanced approach of Marginal Cost of Funding. It is expected to boost the monetary transmission mechanism and pass on the benefits to the economy in the shortest possible time.
  2. RBI has also asked the MCA (Ministry of Corporate Affairs) to create a road map for convergence of Indian Accounting Standards with the IFRS standards. The move was taken in view of resolving discrepancies in the analysis of companies and to be at par with the international standards for normalization.
  3. The real estate sector has been holding on inventories worth Rs. 70000 Crore from the past year, due to the fall in the prices. RBi had asked the realtors to clear the inventories at lower cost since the prices are supposed to be market driven. The response was extremely lukewarm in nature. Thus, RBI has now initiated the move through its monetary tools. It has given banks the liberty to reduce the risk weights on the housing loans, which will bring down their costs and ultimately the cost to the customers. This is an attempt of RBI to make houses more affordable by giving them lower rates of interest. The rates of interest for housing is supposed to hover in the range of 9.5-10%.
  4. With the chances of fed hiking rates in the early 2016 or so, liquidity might face certain pressure in the country. RBI has hence decided to reduce the SLR requirements by 25 bps each quarter till march 2017 to sustain the liquidity crunch that might arise. SLR requirements are supposed to come down to 20% from the current levels of 21.5% (6 Tranches of 25 bps reduction in each quarter).
  5. With a view to making identification of banknotes easier for visually challenged persons, the process for introduction of additional identification marks in banknotes in the form of angular bleed lines has been initiated and is being introduced in the denominations of Rs. 100,  Rs.500 and Rs. 1000 as raised lines on both the left and right sides of the obverse of the banknote: 4 lines in  100, 5 lines in 500 and 6 lines in 1000. Furthermore, the size of the existing identification mark in these denominations is also being increased by 50 per cent to facilitate better identification.
  6. Additionally, the investment by FPI route into the debt markets has been eased to boost investments.

Lets discuss a bit about the markets, will the rate cut boost the returns from the equities and if yes, then what time horizon it will require.

Historical evidence suggests that, with interest rates reducing, companies tend to save on their interest cost, leading to higher profits, high job creation and more demand boosting the revenue growth. The effects of the same, will be seen as increase in corporate earnings and attractive valuation. Generally, whenever rate cuts have led to a meaningful demand push, the corporate earnings and PE ratio have improved. The image below indicates the relationship between the rate cuts and the valuation as well as the corporate earnings.

Relationship Between Int Rate and PE (historical)
Relationship Between Int Rate and PE (historical)

Currently, the state of the economy looks extremely feeble in nature, although it is the fastest growing economy. Data till date, indicates that, if the repo is at or above 8% mark, valuation take a hit whereas if they are around 6%, valuation look up. The valuations are supposed to improve according to the data, but this time the global economies are under intense slowdown pressure. The effects of these rate cuts on the market will be extremely short – lived. I believe, supposing that the transmission improves and interest cost come down, rate cut aid alone can almost never make up for the absence of the household demands and corporate earnings. Although, the current year and the first half of the year 2016 does not seem overwhelming, rate sensitive industries will definitely stand to gain in the current fiscal. Industries like banks, capital good, constructions, auto ancillary etc will be the key beneficiaries. The investments in the equities as of now might not reap you extraordinary returns but by FY 2017, the returns will be substantial in numbers. My recommendation would be stay invested and keep looking for potential value stocks.

To conclude, the inverse correlation between the interest rates and the PE and the valuations usually takes time to unfold. Although, banks have already reduced their interest rates by about 70 bps on an average against a 125 bps rate cut by the RBI. We can only hope for a much better and an effective transmission. I expect the interest rates to come down by another 50 bps in the case of banks in the near future, which might reduce the interest cost for the corporates. Given the low base of corporate earnings in FY 2015, performance should ideally show some improvement on a y-o-y basis from the Dec Quarter. Going ahead, a genuine improvement is unlikely before FY 2017 and only then will we witness some meaningful gains. Short term markets are likely to be bullish, medium term are likely to be neutral, but with the series of rate cuts this year, long-term indications are undoubtedly bullish in nature with the corporate earnings showing improvements. The commodity prices are also expected to be dented in the near future, which might add to the betterment of the economic indicators. Although, the RBI has done its bit in boosting the growth and investment, rest depends completely on the domestic demand pickup in the near future and the Govt reforms.

Thank you. 🙂

Third Bi Monthly Monetary Policy – To hold or Cut the Rates?

The Reserve Bank of India on August 4, 2015 will announce its Third Bi-Monthly monetary policy. As any other policy decision, this one seems to be tough as well. On one side, the GOI recommending a rate cut to make sure that earnings improve and on the other side are the global events that should be considered to make an appropriate decision. The question persists, will the RBI cut rates or will it prefer to hold the repo rates at the current levels and ask the Govt to take the lead in reforms. Let us understand what the various domestic macroeconomic indicators and the global events suggest. We will evaluate the CPI, WPI, IIP, Credit Growth, deposit growth, FII inflows, call money rates of liquidity, global data, and finally ERI (Equilibrium Real Interest being the most decisive factor)

Before we start with it, the following link will give you an idea as to what we predicted in the second bi-monthly monetary policy:

Second Bi-Monthly Policy

In the ongoing year from January 2015, Dr Rajan reduced the repo rate by 75 basis points in the past bi monthly policies. The rate cut was welcomed by the industries for the growth prospects involved, except the banking sector. Inflation targets were achieved with the accommodative policy so far. But the conditions of the second half in future looks to be more challenging for the RBI. Here’s a short recap how repo has been changed since the Rajan era.(Since Sept 4, 2013).

Repo rates.jpg

The top 3 factors, CPI,WPI and IIP growth, have always been the key determining factors for the RBI to take a decision on the repo rate. CPI in the past month has slightly inched up from 5% to 5.4%. Although, it seems to be in the inflation targeting zone of under 6%, the monsoons will have their own share of contribution in the CPI numbers later this year. So far, the monsoons have been as per expectation apart from the first two weeks of July, where we saw 12% below average rainfall. The point to be focused on is that, food inflation has increased in the past month’s data. The core inflation (Non food Non fuel) inflation also headed north. It is also expected that the CPI might head north in the second half of the year because of subnormal monsoons and inefficient Public Distribution Systems. Based on the average CPI for the year, which is hovering very close to the 6% mark, it is important for the RBI to wait for the CPI to decrease further and reach a sustained under 6% level. Right now, it looks likes the Jan 2016 inflation target of under 6% CPI is in doubts. WPI, on the other hand continues to be in the dis-inflationary zone. WPI data indicates that inflation has slightly risen up to -2.4% from -2.36%.

infl-chart-1-1-56

Although, It is evident from the CPI, WPI and the GDP deflator figures that the inflation has eased compared to previous years, the rest half of 2015-16 looks tricky.

capture23

Finally, it also depends upon how the rainfalls fare in the coming months and how does the Govt handle the supply side problems effectively. The interesting thing to watch out for will be IMD forecast v/s Skymet forecast. IIP has slipped to the levels of 2.7% which is quiet disappointing for the markets since it’s an indication of manufacturing output slowdown and subsequently subdued demand as well. Today, the core sectors growth numbers for June declined from 4.4% to 3%. Core sectors (8 of them) hold 38% weightage in the calculation of IIP, which suggests that the IPP might have further downside risk. The Q1 numbers of most companies have not been great, except the private banks. . The markets are hoping that RBI with the Govt might cut rates to boost growth. But, we suspect that they are hoping for the reforms to kick in (GST and Land Bill) instead of a rate cut, in the form of a catalyst.

On the banking front, the deposit growth has been outpacing the credit growth from past few months. Credit growth is at a 17 year low of 9.52%. The NIM and NII are already under some downward pressure because of the consecutive rate cuts. Further reduction of repo rate might drive the credit cycle but will definitely hurt the profitability of banks in the near future, which RBI would like to avoid. FIIs however have been steady in the past month. We witnessed slowdown in the FII inflows in the April- June quarter so far, thus weakening the rupee. Outflows were seen because of weak annual earnings by the corporates and the reforms not getting a green flag in Rajya-Sabha . The issue of P notes recently had triggered an outflow, although the fears were cleared up by the FinMin last week. The volatility index has been hovering around comfortable levels of 16% showing signs of lower volatility in the short-term. The overall liquidity position in the country is in surplus at the moment. With call money rates persisting well below the repo rate and the surplus in the system being mopped up by RBI worth Rs. 8700 Crores via the bond auction route, RBI seems to be in a mood of keeping the tightening stance for a while.

US Fed in its FOMC meet recently announced that the employment and production data has been promising. They have signaled of a rate hike soon, but soon does not seem to be September. We are definitely looking at a rate hike this fiscal by US Fed. Greece Debt crisis although could not have a dent on the rupee lately. China has seen its worst downfall in the past 8 years with its Shanghai index tanking in the most unnatural ways. Crude oil prices are having continuous downward pressure. To facilitate the stability of rupee, RBI might want to wait for the right time for any further cuts.

There is one more problem the country is facing, which is ineffective “Monetary transmission”. The RBI reduced the repo by 75 bps but the banks reduced their base rates by only 30 bps. Banks could not pass on the rate cut to the same extent because of the fear of stressed profitability. In such weak monetary transmission stage, the efforts of revival of economy through monetary measures might not help. From all the data and current state of the economy, Dr. Rajan might want to hold the rates until next notice.

Lets now focus on the most important factor, which is Effective Real Interest rates(ERI). ERI is the rate which is considered acceptable by the central bankers over and above the inflation levels which is right for the economy to grow. RBI considers, average ERI currently apt for the economy is 1.75% over the inflationary levels. With the inflation slightly inching up, as per the ERI calculations, the repo must be slightly more than 7.25 (should be about 7.4-7.5%). But, a rate hike can have some serious consequences on the economy which is looking at a sustained growth rate in the future.

The growth is henceforth more dependent on how the NDA govt rolls out its key reforms of GST and Land Bill. The RBI, witnessing the present conditions, has done extremely well in delivering the dual objective of inflation control and growth. However, after analyzing all the factors, both magnitude and directional in nature, we predict that RBI might choose to hold rates at the current levels of 7.25% in the third Bi-monthly monetary policy. CRR and SLR ratios are unlikely to be changed as the liquidity conditions are surplus. Readers need to be aware of the fact, that RBI is looking for reduction in the two ratios in the future to their minimum levels, which are 3% and 15% respectively. Reduction in those can only be made when there is either high demand for liquidity or a liquidity crunch in the system. Although, if not on 4th of August, we might see some action from the RBI in late September in the form of an “Out of the Policy Cycle” review. Going forward, the rainfall and the outcomes of the ongoing monsoon parliament sessions will decide the direction of growth as well as the financial markets. To sum up, with the next US Fed policy in Sept having more probability of a rate hike, RBI in this policy review might just choose the Wait-N-Watch approach.  

Thank you. 🙂

RBI D Day – A Cut or Status Quo

The Reserve Bank of India on June 2, 2015 will announce its Second Bi-Monthly monetary policy. This policy is a tough one for the RBI to decide because of the various effects of the world economy and the domestic conditions. Question is, will there be a rate cut or a status quo. There are various factors that are likely to be considered by Dr. Rajan to decide on the policy action. Lets take a look at the information based on which probably we can foresee the trend of the policy action due tomorrow.

First and the foremost important factor for the same is the retail inflation. CPI ( Consumer Price Index) has seen a decline since Nov 2013 from 11% levels to the current 4-5% levels. WPI( wholesale Price Index) on the other hand showing deflationary trend. The biggest concern for India since the past 2 years was the rising food inflation. Food inflation, lately, has moderated to 5.4% from highly uncomfortable level of 14.45 % during Nov 2013. Inflation is thus showing consistent downfall and has been averaging at 5.5% which is well below the RBI targets of 6% inflation by Jan 2016. The RBI is focusing on the use of CPI alone post apt recommendations of the Urjit Patel Committee. There are chances that WPI might not be picture after a certain amount of time. But it must be acknowledged that FIT (Flexible Inflation Targeting ) has started showing its positive effects.

While on the industrial growth side, India has shown disappointment so far including the disappointing Q4 earning of 2014-15. IIP (Index of Industrial Production) continues to be anaemic which shrank to 2.10% from 5-6 % levels.Firms’ net profit growth has failed to recover despite rate cuts in the previous reviews. Net profit growth has been hovering around 6.5% from the past 4 years in the Indian economy. While the interest costs as a percentage of net sales, which is of major importance for the domestic companies, has seen a steady increase every year. These conditions suggest that although we are growing at 7.3% annually, there is a hint of slowdown in the industrial sector (organized Industrial sector to be accurate).

On the BFSI sector side of it, the commercial credit growth has shown a continuous downfall from 16% to around 10.5% in two years time. This condition seems to be horrifying for the banks and its performance on the NIM(Net Interest Margin) and NII(Net Interest Income) aspects. Deposit growth has been subdued as well.

FII fund flows into Indian markets have also been declining amidst the delays in the structural and tax reforms. Markets have been witnessing high volatility in the recent past, with its IV(Implied Volatility) well over 20%, which is not a good sign. Value of rupee has also shown a downward trend against the dollar thus increasing the value of import burden.

Liquidity conditions in the economy also seem to be comfortable looking at the prevailing call rates. RBI has made sure that enough liquidity is available in the system without compromising on the rupee value. Call rates have been consistently steady at 7 – 7.5% levels, indicating comfortable levels of liquidity, and well within the repo operation window of 6.5%(rev Repo rate) to 8.5%(MSF Facility rate). This liquidity comfort is thus indicating greater probability of a rate cut tomorrow.

US Fed on the other hand has been indicating signs of increasing their interest rates in the Sept FOMC meet. But looking at the US Govt statement on Friday 29th June, where they reduced the forecast of 0.2% annual growth to a shrinking growth of 0.7% due to weak Q1 growth, it looks tough for the Fed to increase rates in the near future. Thus giving RBI the scope of easing its monetary policy.

All the factors of inflation easing, commercial credit growth declining, pressure on NII, negative fund flows from FIIs, subdued corporate earnings, steady liquidity conditions and the increasing cost of interest are signalling towards a rate cut.

All the above factors are a guidance about the direction of the repo rate. There is one factor which is being considered by all central bankers for decisions on the operational rate cutting. This factor will ultimately determine the size of the rate cuts going forward depending on the economic conditions. The factor is popularly known as the Equilibrium Real Interest. This is the move of central bankers towards discretion as to what is should be the ideal rate for a certain economy. ERI is the rate which is considered acceptable by the central bankers over and above the inflation levels which is right for the economy to grow. RBI considers ERI should be 1.5% to 2%. Current inflation averaging at 5.5% and considering an average ERI of 1.75%, it might be apt that the ideal rate would be 7.25% in the current configuration.

images

Considering all the factors of magnitude and direction of the repo rate, RBI in its Second Bi Monthly Policy might cut repo rate by 25 bps to 7.25% or even 50 bps if Dr. Rajan decides to surprise the markets yet another time. It is unlikely that RBI will maintain status quo looking at the factors in play. CRR and SLR on the other hand might not be disturbed at the moment since the liquidity condition seems comfortable. The effects of the monsoons and the EL Nino is still an unanswered issue which can be only witnessed in the near future. Presently, some rate adjustments are certainly due in India as well as US, but its likely that the RBI will step on the gas first to spur growth as well as contain inflation.

Thank you 🙂