Monetary policy maintains status quo on repo rates…

The monetary policy announced by the RBI on 07th June maintained status quo on the repo rates. This was along expected lines. The lower levels of inflation and the tepid growth in GDP did make a case for a rate cut on a theoretical basis. But, the RBI had different ideas. Their view was that recent data on inflation and growth may be temporary and may not be reflective of the larger structural reality. Here are the key takeaways from the Monetary Policy announcement…

Key takeaways from the Monetary Policy on June 07th…

  • The repo rate was kept static at a level of 6.25%. As a result, the reverse repo rate (fixed at repo-25 bps) stayed at 6.00% while the Bank Rate (fixed at repo+25 bps) stayed at 6.50%. This was largely along the lines of the market consensus.
  • Since the beginning of January 2015, the RBI has cut the repo rates by 150 basis points from 7.75% to the current level of 6.25%. While the bank rate has also fallen in tandem with that, it has seen a further cut of 75 basis points due to the yield spread with the repo rate being compressed from 100 basis points progressively to 25 basis points. Thus the bank rate has fallen from 8.75% in January 2015 to the current level of 6.50% signifying a total reduction of 225 basis points. The bank rate is a crucial parameter as it is the benchmark on which banks price their loans.
  • Over the last couple of years, the big challenge for the RBI was to ensure transmission of rate cuts to the end customer. However, till November 2016 the banks had passed just 50% of the rate cuts to the end customer. However, things changed after the demonetization drive in November 2016. Banks were flush with funds that came in the form of deposits and were therefore forced to cut rates to improve credit demand. In fact, banks like SBI went to the extent of cutting their MCLR by as much as 90 basis points. This ensured that transmission of rate cuts since January 2015 had almost touched 100% by January 2017.
  • One of the key guiding factors for the RBI on the rates front is the rate of CPI inflation. In fact, CPI inflation touched a low of 2.99% in April 2017 which is almost 100 basis points lower than the RBI best case estimates. However, the RBI in its monetary policy has expressed scepticism that such a low level of inflation may not sustain and the inflation in the second half of the current fiscal year may gravitate back to the 3.5-4.0% range.
  • The RBI has 3 justifications for this view on inflation. Firstly, rural and semi-urban inflation has been low since November 2016 due to the weak demand in the aftermath of demonetization. Secondly, cheap oil and a strong rupee had created a virtuous cycle of low inflation in India, which may not sustain through the current year. Lastly, there was a glut of pulses and cereals due to a good Kharif crop in 2016. With the government likely to permit a bigger export quota, that advantage is unlikely to sustain.
  • The second major consideration for the RBI was the tepid growth rate. Normally, the RBI does use growth as a criterion and tepid GDP growth is a veritable trigger for a rate cut. In the October 2016 policy announcement, the Monetary Policy Committee (MPC) had specifically justified the rate cut of 25 bps on the grounds of weak growth data. That did create a base case for the RBI to consider a rate cut in this policy.
  • However, the RBI has chosen to maintain status quo for a few basic reasons. Firstly, the weak growth was the lag effect of demonetization. The next 2 quarters may give a better idea of the pick-up in growth post remonetization. Secondly, the higher rural outlays and the payouts due to OROP and 7CPC are expected to generate higher demand in this year leading to higher growth. Lastly, the RBI is of the view that even if the rates are cut at this point of time, the mountain of stressed assets will prevent a proper transmission. Hence a rate cut may have defeated the purpose.
  • The RBI also had the issue of consistency of its stand. In the last 2 meetings of the MPC, the monetary stance of the RBI had clearly shifted from an Accommodative stance to a Neutral stance. It may be too short a period and too few data points to justify a change in stance. The RBI will prefer to await more data points over the next couple of months. However, by acknowledging a lower inflation trajectory, the RBI has indirectly given a dovish signal.
  • Going ahead, the RBI may have subtly set the tone for a future rate cut. For the first time, there was a voice of dissent within the MPC with Dr. Ravindra Dholakia insisting on a more dovish approach to rates. To that extent, the MPC has walked away from a 100% consensus. Over the next quarter there will be additional data points in the form of monsoon progress, Kharif output, inflation, IIP, trade data and Fed related cues. If a majority of the cues are favourable, then the RBI may have a much stronger case for a distinctly dovish stance.

We will have to await more details of the MPC debate which will be made public on 21st June. That may give more cues on how the RBI will respond when it meets next on August 02nd for the next review of monetary policy.

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