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Credit policy maintains status quo on rates but maintains dovish stance...


Posted on 01-Dec-2015 Comments  1

The RBI announced its Credit Policy review on December in the light of an interesting macroeconomic backdrop. On the domestic front CPI inflation has inched up to 5%, which is closer to the RBI comfort level of 6% for the year 2016. GDP growth for October has come on expected lines at 7.4% while core sector growth at 3.2% was in line with previous months. The immediate metrics for the RBI will be the liquidity impact of the $15 billion annual payout as an outcome of the Fifth Pay Commission.


At a global level China continues to slow down to nearly 6.4% even as the Chinese Yuan has acquired the status of hard currency by being included in the SDR basket. The big uncertainty is the US FOMC rate action. Traders and analysts are already assigning an 80% probability to a rate hike in December. In the light of this macroeconomic background, the RBI was not expected to cut rates in the December policy. But first, the highlights of the Credit Policy...


Highlights of the policy announcement...


·        The RBI has kept the Repo Rate unchanged at 6.75%.

·        The CRR has also been left unchanged at 4% of net demand and time liabilities (NDTL)

·        The statutory liquidity ratio (SLR) has also been kept unchanged.

·        RBI will continue with repos and reverse repos to smoothen liquidity

·        As a result the reverse repo rate will remain unchanged at 5.75% (repo-1)and the Bank rate will remain static at 7.75% (repo+1)

 

Why did the RBI adopt await and watch mode...


Broadly 4 factors guided the RBI when it decided to maintain policy status quo and putof a rate cut decision to the February policy:


 

     Inflation at 5% did not leave much headroom for the RBI in terms of interest rate leeway. Food inflation continues to be sticky; first it was onions, then it was pulses and now it is tomatoes. Food inflation has been spiralling despite the government’s best efforts to manage supply mismatches.

     The Fifth Pay Commission has agreed to a $15 billion additional payout to government employees. If the state governments are also added, this payout may well go to $30 billion. With so much additional liquidity in the hands of the public, the RBI wanted to ensure that inflation will remain under check and easy money does not lead to a credit binge among retail.


     Rate cut transmission is not happening. The RBI governor has expressed disappointment over the fact that out of 125 basis points of repo rate cuts in 2015, only 60 basis points (less than 50%) was actually passed onto the borrowers. Bank credit has grown at just 8% in the first 6 months and manufacturing sector had actually seen negative credit growth. Hence there was no rational justification to persist with further rate cuts.

     The US Fed decision continues to be the joker in the pack. A rate hike in the US is anyways likely to be negative for emerging market capital flows. Additionally, the inclusion of the Yuan in the SDR basket will mean that the Yuan will strengthen in the short to medium run. Hence the RBI had to keep debt yields competitive to ensure that capital flows are not negatively impacted.


Inflation could be a two way street for the RBI...


The RBI has expressed confidence that the persistence of cheap oil and commodities is likely to sustain through 2016. Firstly, oversupply and stockpiling is likely to keep oil prices low. Secondly, weak demand from China (with PMI below5 0), is likely to keep commodity prices worldwide depressed.  However, inflation could get a leg up from two key factors.

The first is food inflation. Both services inflation and food inflation have been quite sticky. Food inflation is likely to continue as indicated by the weak Rabi sowing season. So despite best efforts on supply management, food inflation may continue to prevail.

Secondly, the impact of the $15 billion 5thPay Commission payout is still not properly assessed. However, a quick assessment indicates that it could definitely be inflationary in the short to medium term. RBI is also worried that due to the Pay Commission payout, the fiscal deficit target of 3.5% may come under stress. That by itself is inflationary.


The good news is that the RBI has maintained a dovish stance...


If there is one reason for industry to celebrate, it is that the RBI has maintained its dovish stance. The RBI has made it clear that the bias of the RBI will be towards easing of rates even from current levels. The following are the key takeaways...


     To ensure that better transmission of rate cuts happen, the RBI proposes to shift banks to a marginal cost approach to fixing base lending rates. As opposed to the average cost model used currently, the new methodology will ensure seamless transmission of rate cuts. The RBI will prepare the consultative paper this week.

     While the RBI has expressed concern over inflation, it is confidence in the commitment of the current government to keep expenditure and fiscal deficit under check. This tightening should largely negate the inflationary impact of the Fifth Pay Commission.

     That essentially leaves the door open for further rate cuts if the situation warrants. Once there is clarity about the Fed intent and timetable on rate hikes, the RBI may be able to take a clearer view when it has its next policy review on February 02, 2016. That seems to be the good news emanating from the policy.

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Navias New Brand

Posted on 12/14/2015 3:34:44 PM

Nice One

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