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.

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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. 🙂







Wrong Move?

The US Fed, in its last policy meet for the year, held on 15th and 16th of Dec, decided to break it’s near zero interest rate trends. The US Federal Reserve on 16th Dec, 2015 decided to raise its interest rates for the first time after the sub-prime crisis era. Although, the hike was anticipated much earlier in the year, lack of strong data in terms of unemployment rates and inflation was a hindrance. Ultimately, on the basis of fairly strong data, the Fed has decided to step on the gas. The question is” was this a wrong move”? In this blog, I will focus on the data considered by thr Feds for a policy action, inflation targeting, rationale behind the rate hike decision, why is the hike unconventional and the history of the impact of such unconventional measures. To conclude, I would provide an insight on the policy modes of the major economies, the likely impacts on the US economy, global growth and the financial markets worldwide.

The Federal Reserve, in its final policy for the year, increased the interest rates by 25 bps from 0%-0.25% to 0.25%-0.50%. Fed was focusing on the data from the past 5 years to understand the feasibility of a rate hike. For the readers, it is important to know that a rate hike will start taming inflation and choke the growth in the medium term. Feds have been closely tracking two critical indicators namely, unemployment rate and the retail inflation numbers. Feds had their targets for unemployment rate to drop below the 5% levels while inflation rates to touch 2% trending northwards. The growth rate so far has been on the lower side, but as every other developing and developed economy, the US is has a focused inflation targeting.

Here’s a graph to explain the readers briefly the interest rates and inflation trend:

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Interest Rate Trend 2005-2015
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Inflation Trend 2005-2015
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Feds Target Line Not Crossed

The rationale of the US Fed behind the rate hike was a fairly upward trending inflation and lower unemployment rates. The above images show that, despite not achieving the inflation target and the unemployment rate benchmarks, the Fed increased its interest rates in a non conventional manner. The tone of the policy statement indicated that they are expecting the inflation figures to rise further and the unemployment rate to continue its downward trend as shown in the graph. Inflation is rising but the average figures for the year 2015 is 0.5%. It is unlikely that the figures will rise up to the 2% levels  in the near future due to lack of domestic demand in the US.  On the other hand, a rate hike will choke the growth as well as tame inflation, which will beat the purpose of the rate hike  in the first place. Secondly, the Fed said they expect the unemployment rate to inch downwards from here on. But here’s what has happened from 1971 till date to the unemployment rates whenever the interest rates have been change. Unemployment is directly related to the movement of the interest rates. The below graph and the movements suggest that even the intent of bringing the unemployment rate down is not achieved with a rate hike. Its a challenge from here on how the Feds are going to contain the effects or if I may say the ill-effects of the decision.

Whenever interest rate has increased, the Un-employment rate has increased as well and vice versa

Lets take a look at the history of the effects of unconventional policy actions. European central bank raised the rates twice in 2011, killing a nascent recovery and plunging the euro zone into a double-dip recession that it is still struggling to overcome. In between the years 2004-06, Feds steady quarter point increase in the rates (which was an attempt to avoid the bubble creation), was not enough to stop the implosion of the housing bubble in 2008. In the above mentioned scenarios, the problem was either the central banks acted too slow or too fast, whereas it would have been prudent to take appropriate actions. 

With growth still sputtering in Europe, the ECB has been embracing the tools used by the Feds years ago to revive the economy i.e Quantitative Easing. ECB has kept its rates to near zero levels to try and revive the economic conditions with QE, although the revival might take a little more time than expected. Whereas in Asia, PBOC (People’s Bank of China) is also on a easing mode. Similarly Japan is keeping its interest rates at rock bottom levels to encourage growth. India as well has joined them by reducing its interest rates by almost 125 bps from Jan 2015. With the globe on easing mode, it is going to difficult for the US to justify its tightening with the global growth being already quiet subdued. The growth rates for the US in the first half of 2017 are expected to be on the lower side because of the tightening. US also has been a reasonable contributor to the global growth, and with this tightening we can expect a much lower share from the US and consequently lower global growth. The USD as well is expected to harden against the rest of the currencies hurting the exports and thus undermining the trade balance. Markets all over the globe are expected to reap fairly low returns as compared to last year in the medium term. To sum up, with its unconventional policy actions of a hike when the rest of the economies easing to spur growth, the Fed has increased the probability of a further slowdown in the US. If there is no inflation, the growth cannot happen or if I may say if there is no growth, there might not be any rise in the inflation. Currently, US does not have either in place (Insufficient growth to drive inflation and insufficient inflation to drive growth). But, on the brighter side, with US, China, Europe and Japan on a slow lane, India might be the star performer in the coming year with highest growth rate in the emerging economies as well as the world. But, with winter session wiping out without the GST passage, the path on the fast lane does not seem to be easy. However, the prospects for India are significantly good from here on with an expectation of the reforms rolling out in the budget session.

Thank you.



Gold’s Bleak Outlook

Gold. The word itself brings a lot of joy in the minds of Indians (especially the ladies out there :P). But, is gold a great investment in the current economic conditions ?? Would it be wise to buy gold right now or later in the coming years?? The answer is doubtlessly later in the coming years. Here’s why.

The equity markets have been doing very well from the past 15 months, since the NDA came into power. Global economies are as well picking up and are expected to revive in the coming years. This clearly indicates that, the global equity markets are also expected to do well in the near future which will probably put downward pressure on commodity prices. Indian gold prices anyways are in disparity because of the duty structure, and if these are reduced then the gold prices will decrease further. The import duty has already been curtailed.

Gold is the last investment you can make right now. Reason being very simple and completely market related. First and foremost being the returns, especially long-term returns, have always been lower than the overall equity returns. Returns on gold and gold funds have been negative as compared to equities in short-term, while in long-term they have generated returns of 8-9% levels against 15-16% of that of the equity markets.

Many would be of the opinion that ” Gold is a hedge against inflation“. But today we are looking at consistent inflation levels of 5-6% for the past 8 months and RBI with its FIT(Flexible Inflation Targeting) Policy intends to keep it at a level beneficial to the economy ( As it is said a certain level of inflation is good for the economy to grow). Gold as a hedge as well fails in this situation since there is hardly any inflation persisting.

Right from olden times, there is a lot of opacity that exists in gold trading. This causes a lot of loss for an investor or a buyer if he is not well-informed about the scheme and its loop holes. But never the less, the sellers make sure they make amazing profits from the same( thanks to ever-increasing Indians’ love for gold)

“Buy gold and keep them as gold deposits if you want returns is another myth”. Now when we say returns, always remember it should be more than the current inflation figures. If those are not exceeding inflation, you are not getting returns, but rather losing your value. And gold deposit schemes ?? Really ?? Interest rates of 0.75% for three years is hardly any return. A return of 0.25% per year, which if compared to current inflation of 6% would get you a return of -5.75%. Thank god, gold has appreciation of its value else with gold deposit schemes investors would have been in depression.

Invest in gold only for reducing risk on your overall investment portfolio, because they truly are a hedge against the highly unpredictable downside of the equities. To all those who already bought gold at the high rates of 27000-28000 levels, it will definitely help you in reducing the downside if at all you have invested in equities. Others, wait for a while, this bull run might not last for more than a year or two ( the Modi effect is already showing sign of fading away). The best use of your money as of now would be investing into equity directly or through a mutual fund route. Avoid investing into gold, until next year, unless you can put it to use immediately (consumption like in a marriage or to make ornaments. If you are a first time investor of gold, one should prefer coins over physical gold because of the lesser transaction costs of coins. Always remember this one guru mantra : When you equities are doing well commodities(gold) will always lose value and vice versa. No need to buy additional physical gold looking at the current levels of holdings of the Indian families  😉

Happy investing. Thank you.