RBI Policy – No rate cuts and language continues to be cautious…

The Credit policy on December 01st was announced in the background of mixed macroeconomic signals. On the one hand the possible Fed rate hike is likely to make the dollar stronger. On the other hand, the inclusion of the Chinese Yuan into the SDR basket on 30th November means that the Yuan will strengthen due to increased demand for the currency. Both are likely to influence capital inflows into the US and China positively. The RBI therefore needs to ensure that India’s capital flows do not get competitively outdone. This will be the primer driver for the RBI.

Macroeconomic data coming out from India has been quite positive. The annualized GDP growth for the month of October has come in at 7.4%, which is in line with the full year estimates for GDP. The core sector and the manufacturing sector are, probably, showing the first green-shoots of economic recovery, although construction and oil have lagged behind other sectors. Inflation at nearly 5% continues to be a challenge and that is a critical factor influencing the colour of the credit policy. It is in this domestic and global macroeconomic background that the credit policy for December 01st was presented by the RBI. 

Highlights of the Credit Policy…

  • 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)
  • 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) 

Macroeconomic review by the RBI…

The RBI has expressed concerns over the weakening of global economic growth in the last quarter as well as the contracting of world trade during the last one year. On the domestic front, the GDP is in line to meet the annual target of around 7.4% growth helped by green-shoots of recovery in the core sector and in manufacturing output. The agricultural output has also shown signs of improvement by almost 1% in October, which is commendable despite a deficient monsoon. This is largely attributable to timely policy interventions which could largely negate the impact of low Kharif output on prices.

Areas of economic focus identified by the RBI…

The policy statement has focused on a few key focus areas for the RBI:

  • CPI inflation is on an uptrend for 3 months and at 5%, it is quite close to the RBI’s long term comfort level. This needs to be controlled.
  • The manufacturing PMI is at a 2 year low of 50.3, very near to the classification line between an economic expansion and economic contraction. This has to move comfortably above the 50 mark.
  • Contracting exports need to be addressed urgently, despite falling imports. The comfort level of 10-12 months import-cover of forex reserves need to be maintained.
  • On the global front, the RBI has expressed concern over the divergent monetary stance of the Fed and the ECB. This may cause divergence between the dollar and the Euro with negative implications for the Indian economy in terms of cross currency risk.

Policy stance adopted by the RBI…

 While the RBI does not believe that the Fed rate decision should have a major bearing, they would still prefer to wait out for the Fed stance before taking a call on further loosening of monetary policy.

  • RBI has also expressed concern that the $15 billion annual payout as a result of the Fifty Pay Commission recommendations should not stoke retail inflation or a credit binge among retail. The policy rate would also be contingent on this factor.
  • Inflation, of course, continues to be the key factor to watch out for. RBI had front loaded rate cuts in the previous policy in the hope that inflation would not cross the 6% mark in the whole of 2016. However, inflation has already touched 5% in September and hence caution is warranted, especially on the food inflation front.
  • Transmission continues to be a concern for the RBI. According to the RBI, only 60 bps out of the 125 bps repo rate cut was actually transmitted. This surely leaves room for the banks to work on more effective and seamless transmission.

What aspects of the policy could have long term implications?

There were 2 aspects in the credit policy which could have long term implications for banks in particular and the macro-economy in general:

  • The RBI will shortly finalize the methodology for determining the base rate on the basis of marginal cost of funds. This will be negative for banks which have been enjoying the benefit of using average cost of fund s and enjoying part of the repo rate cuts. Under the new dispensation, the rate cuts will become virtually seamless to the customer.
  • There is also a proposal to link the small savings rate to the market rate. This has long been a demand because the high rates on small savings plus the tax benefits tend to distort the rate structure in India. This will help create a vibrant debt market as well as a more credible yield curve in India.

In a nutshell, the RBI policy was largely in line with expectations. The RBI is right in taking time off to observe the impact of the Fed rate decision before taking a call on further rate cuts. But most importantly, the RBI has focused on the all-important transmission of funding costs to the end borrower. Food inflation, of course, will be the key metrics as that continues to still be a function of monsoons and reservoir levels and could be the biggest upside risk for CPI inflation. How the above 3 factors shape up in the next 2 months will determine the stance of the RBI in its next policy on February 02nd 2016.

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