RBI Credit Policy

RBI Governor may hold rates this time around…

As another credit policy approaches on December 01st, the key question is what does it hold? Of course, the key question boils down to whether the RBI will cut repo rates or not. In all likelihood, the RBI may prefer to wait and watch. It will prefer to maintain status quo in this policy and take a fresh view on rates in the next calendar year. There are 4 key reasons why the RBI will not cut repo rates in this policy.

Inflation has shot up sharply

You can call it the vanishing of the base effect, but the fact is that CPI inflation has shot up sharply in the last 2 months. In October, the CPI inflation was up to 5%. This is quite close to the RBI comfort level of 5.5% for the whole of next year. Also, food inflation is proving to be sticky as onions, tomatoes and pulses have been taking turns to skyrocket. Unless the food inflation is tamed and CPI inflation comes below 5%, RBI governor will not be too keen to cut repo rates.

Directing credit properly

The RBI would want to ensure that the credit gets directed properly. Mutual fund collections show that retail investors are flush with liquidity. The government has also accepted the recommendations of the 7th Finance Commission. That is likely to add an annual payout of $15 billion to government employees. State governments will also affect a similar payout. A $30 billion liquidity boost in one year is huge. The RBI will want to ensure that low interest rates do not lead to a credit binge among retail.

Show me the transmission…

That continues to be the big challenge for the RBI. Despite 125 bps cut in rates in 2015, only 40% has been passed on to the end customer. Also credit off-take continues to be lackluster. Take the case of bank credit in the first half. The growth in bank credit was just 8% and manufacturing credit actually showed de-growth. The riddle for the RBI is; if rate cuts are not resulting in transmission or in higher credit off-take then what is the purpose. That may compel the RBI to pause on rates.

Fed meeting could be the key…

But the real challenge for the RBI will be to estimate what Janet Yellen will announce on December 15-16. The probability of a rate hike is now placed at nearly 80%. If a rate hike were to happen, the RBI will want to ensure that foreign debt investors stay on in India. That will require higher bond yields. A pause in rate cuts may be RBI’s best bet to sustain foreign investor interest in Indian sovereign debt.

In all likelihood, the RBI will pause in December. Clarity on inflation and Fed rate action will be key parameters! ©

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