RBI Credit Policy – Investors get more than they bargained for…

If there was one way to describe the RBI policy announced on 29th September 2015, it was a policy that exceeded expectations by a margin. Markets were expecting a 25 bps rate cut and preparing for a zero bps rate cut with a hawkish tone. What the markets actually got was a pleasant surprise! The RBI cut rates by a full 50 basis points and did not rule out further rate cuts, thus keeping the tone as dovish as possible. Also there were some more items for the markets to rejoice.

With the latest 50 basis points rate cut, the RBI has cut 125 basis points for the full calendar year till date and has also left room open for further cuts when the next policy meet happens on December 1, 2015. The key now would be to ensure that the rate cuts are seamlessly passed on to the end customer. But first, the highlights of the policy announcement…

Highlights of the credit policy announcement…

  • The repo rate has been reduced by 50 bps from 7.25% to 6.75% with immediate effect.
  • Consequently, the reverse repo rate stands reduced to 5.75% while the marginal standing facility (MSF) rate stands reduced to 7.75%.
  • The cash reserve ratio (CRR) for banks has been retained at 4% of net demand and time liabilities (NDTL).
  • The RBI will continue to provide variable rate repos and reverse repos to smoothen liquidity in the system.

Global background to the policy…

Since the last policy announcement, the US has shown signs of growth picking up. The EU has continued to falter although he Euro currency has shown strength vis-a-vis the US dollar. However, the big area of concern has been China where growth has slowed down from over 10% to closer to 6%. The Chinese PMI at 47 is indicating a strong loss of momentum in growth and that is likely to weigh heavily on Chinese demand. This is negative for global markets, especially the commodity baskets like Latin America, Central Asia, Australia and South East Asia. According to the RBI, this could be the one major risk for global growth and future policy structure will be largely influenced by this factor.

Inflation seems to be finally under control…

The theme of the policy statement seems to be that inflation is finally under control. There are concerns over the base effect of inflation for the months of August and September. However, the RBI has expressed confidence that inflation is likely to stabilize at around the 4.8% levels for the financial years 2016 and 2017, which is well within the stipulated limits of the RBI. This guidance of low inflation means that the RBI has taken a dovish approach to rates and therefore markets can actually expect more cuts going ahead. Of course, the RBI has once again expressed the hope that rate cuts get transmitted more seamlessly. This should happen on its own once banks shift to the incremental cost-based funding for loans rather than the average cost of funds that is used currently.

Some additional measures for financial markets…

Considering that FPIs have been complaining about inadequate limits in government bonds, the following measures have been announced in the policy announcement. The limits for FPI investments in debt securities will be henceforth announced in Rupee terms. The limit for FPI investment in government securities will be increased in phases to 5% of the outstanding stock by March 2018. This will open up an additional room of Rs.1,200 billion over and above the Rs.1,535 billion for all G-Secs. Additionally, Indian corporates will be allowed to issue rupee bonds in overseas centres with appropriate regulatory frameworks. Such bonds will have to have a minimum maturity of 5 years. To broaden and deepen the currency futures market, the policy has also permitted stand-alone PDs to participate in the currency futures markets.

Credit Policy: Summing it all up…

In a nutshell, this policy draws the perfect balance between the call to manage inflation and the need to spur growth. The RBI has given the initial spurt for industrial growth. Banks need to move towards better management of NPAs and more seamless passing of rate cuts to the end customer.

When the RBI meets up for the last policy of the calendar year on December 1, 2015, there will be an additional overhang of the Fed decision on rates. It now seems much more certain that the Fed will hike rates in December and that will weigh on the RBI when it meets in December. The RBI will not want a situation where the risk-off trade is playing against India and a rate cut only worsens the situation. That will be the biggest trade-off for the RBI in the next policy. As of now, the RBI has taken the initiative to spur growth. The ball is now in the court of banks and industry to ensure that these monetary efforts get translated into concrete action at a grass-root level.

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