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:

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. 🙂