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 🙂

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:

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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:

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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. 🙂

 

 

 

 

 

 

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.

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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. 

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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.
🙂

Fourth Bi-Monthly Monetary Policy – Expectations v/s Reality

The Reserve Bank of India will be rolling out its fourth monetary policy review for the year on 29th Sept,2015. The opinions so far are mixed in nature about whether RBI will choose to maintain status quo or cut rates for the fourth time in a year. Although, the markets seem to expect a rate cut of 25 bps, Dr. Rajan will have his own judgement of the situation. Let us understand what the various domestic macroeconomic indicators and the global events suggest. We will also briefly discuss about the FOMC meeting held on 16th and 17th Sept and its outcome. We will evaluate the domestic factors such as CPI, WPI, IIP, Credit Growth, Deposit growth, call money rates for liquidity, stability of rupee, global data, and finally ERI (Equilibrium Real Interest being the factor that decides the quantum of a rate cut, if at all there will be one).

For the readers ready reference, the following link will give you an idea as to what we predicted in the third bi-monthly monetary policy:

Third Bi Monthly Policy

The overall signals from the global events indicate that the global growth is slowing down. China being the predominant contributor in the same. Euro zone, is still struggling with the deflationary scenario. ECB, in its recent monetary policy review, kept its rates unchanged at 0.05% and decided to continue with the ongoing monetary stimulus in the form of Quantitative Easing. Federal Reserve, on the other hand, also decided to maintain status quo in their policy review. US Fed briefly decided based on two important factors, namely, unemployment data and retail inflation. The unemployment data was below the 5% target levels of Fed but inflation still showed persistence at near 0% levels. The FOMC implements its policies based on FIT( Flexible Inflation Targeting). With such disappointing data, Fed hence decided not to hike the rates and maintained a status quo at 0-0.25% rates, which indirectly has given a room for a repo cut.

IIP data, published for the month of August, showed a sharp rise to 4.2%, which clearly suggests that a rate cut might not be required when the manufacturing sector has expanded well. IIP was majorly driven by manufacturing, electricity and surprisingly agriculture as well. WPI, on the other hand, continued its downward deflationary trend and stood at -4.95% as compared to near -4% levels last month. Looking at WPI as a stand alone data, its does indicate the required room for a 25bps rate cut. CPI, the retail inflation indicator, which is an indicator that RBI monitors closely before a monetary policy review also eased to 3.66% from 3.69% (july) in August. Although, the CPI seems to be eased, it is suggested by the RBI that the fall was largely due to the base effect, excluding which it would be around 5.5%. Overall, CPI numbers are suggesting a rate cut, but my take is that the base effect will play a major role in deciding the actual values. The trajectory of CPI in the future seems to have upside and if not tamed, RBI might miss its sub 6% inflation targets by Jan 2016.

CPI Inflation Trajectory so far...
                                                            CPI Inflation Trajectory so far…

The banking sector seems to be struggling in its growing NPA numbers and higher cost of funds. Credit growth (9.8%) is still being outpaced by deposit growth (11.56%) which is a cause of worry for the banking business. RBI, with its draft guidelines on moving to Marginal Cost of Funding from the old system of Average Cost of Funding, has suggested the banks to not rely solely on rate cuts for reducing the costs. RBI has also rolled out a few reforms for efficient lending and management of NPAs in the past few months. Recently, to facilitate the corporates, it also liberalized the External Commercial Borrowings norms.

We have to expand the sustainable growth potential. That means continuing to implement reforms that the government and the regulators have announce. That is the only way to get sustainable growth potential up – Dr. Raghuram Rajan

With the call money rates at 7.28%, which are well within the repo window of 6.25% and 8.25%, the liquidity condition seems to be quiet comfortable and certainly rules out any chances for further monetary easing. Rupee in the past two months has depreciated by about 3% amidst yuan devaluation. Maintaining the stability of rupee is a challenge for the RBI and any further easing might lead the rupee to depreciate further. Although, India has fared well against the other countries in the emerging economies group, its is unlikely that the RBI would be comfortable allowing the rupee to depreciate further. On a quantitative note, as I mentioned in previous blogs, RBI is comfortable with an Effective Real Interest rate of 1.75% over and above the average inflation. The average inflation in India for 2015 is at 5.96%. Adding the ERI to the inflation, it is unlikely that there is any room for rate cuts.

While fellow BRICS (Brazil, Russia, China and South Africa) were in distress, India has seemed to be an “Island of Tranquility” – Dr. Rajan

Summarized Parameters
  Summarized Parameter Indications

The parameters, which are predominantly domestic, as mentioned in the above given image suggest that the RBI should probably wait a little longer on their decision to cut rates. Although, the ‘FED’ maintained a status quo, it is likely that they might raise the rates by Dec 2015 if the data is supportive enough. The RBI is likely to maintain a status quo and pass on the next set of triggers on to the Government reforms, since the RBI has indicated that they will focus on long-term inflation targeting rather than quick impatient fixes for the economy. RBI would be happy if the growth path hereon can be spearheaded by the reforms with respect to the GST and its smooth functioning in ease of doing business. However, after analyzing the relevant factors, in terms of magnitude and direction, I predict that the RBI might choose to maintain the status quo at 7.25% in the Fourth Bi-monthly monetary policy. CRR and SLR ratios are also likely to be untouched as the liquidity conditions are surplus. 

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).

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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%.

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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.

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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.

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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 🙂