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 🙂

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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%.

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.

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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 🙂