RBI kept the benchmark repurchase rate at 7.75 per cent, but cut the statutory liquidity ratio (SLR) – the amount of funds that lenders must set aside – by 50 basis points to 21.5 per cent of deposits from February 7, a move that will help banks to increase lending.
RBI policy: cautious on external sector. The RBI was neutral in this policy as it stayed away from any policy rate action (except SLR cut of 50 bps to 21.5%). Given the cautious outlook on global monetary policy dynamics, the RBI focused on addressing issues related to FPI debt flows along with relaxations in the currency derivatives market. We believe that the next cut of 25 bps is more likely to be on April 7 rather than in March.
Concerns on external flows and global monetary policy dynamics gain importance
Having reduced the policy rate on January 15, the RBI was more focused on concerns related to global policy dynamics. The divergent monetary policy dynamics can create headwinds for India and having seen the ill-effects of sharp and sudden risk reversal, the RBI highlighted its cautious outlook. The steps to encourage more durable debt flows within existing limits were testimony to the fact that the RBI intends to safeguard the economy from any sharp debt outflows either during the Fed’s interest rate hike cycle or any other global risk-off phases. The RBI is also wary of an appreciating INR in a phase of competitive currency devaluations globally. This risks INR being overvalued (real basis), which could hurt India’s long-term competitiveness.
Comfort on inflation but global spillover risks need to be monitored
The RBI remains comfortable on the inflation trajectory. However, it highlighted risks from (1) monsoon uncertainty and (2) reversal of crude prices due to geopolitical events. More important, “heightened volatility in global financial markets, including through the exchange rate channel, also constitutes a significant risk to the inflation assessment”. However, the rebased GDP series and yet-to-be released rebased CPI series will also need to be evaluated to understand how the data releases stack up. The RBI maintained its January 2016 CPI estimate at 6%. For
FY2015, the RBI maintained GDP growth at 5.5%, while the estimates pick up to 6.5% for FY2016.
Rate cuts: when next? April 7 more likely than outside policy review cycle in March
The RBI had highlighted on January 15 and also reiterated in this policy that “key to further easing are data that confirm continuing disinflationary pressures. Also critical would be sustained high quality fiscal consolidation…” While probability of the next cut is equal between March and April, we would pencil in April as the next policy move of 25 bps rate cut. We believe the RBI would want to revert to the scheduled policy-decision cycle unless the Budget significantly surprises positively by showing both consolidation as well as improving the expenditure quality. We believe adhering to both the counts will be difficult for the government, especially if it combines pragmatic assumptions on tax-revenue collections.
Rate cuts: how much? 50-75 bps more in CY2015
Governor Rajan reiterated that a comfortable range for the real policy rate is 1.5-2.0%. Based on our estimate of average CPI inflation of 5.5-5.7% in FY2016, there would be room for the repo rate to go down to 7.0-7.25%, with a cut of 25 bps at each stage. 10-year India G-Sec was pricing in a policy rate cut on Tuesday and had moved to 7.65% in early trades but reverted to close at 7.73%. With the terminal repo expected as above, we think that the 10-year yield could trade down to a zone of 7.25-7.50% in FY2016. Risks to this call could emerge from reversals in crude oil prices or sudden changes in global monetary policies.
Key decisions in February 2015 credit policy
Policy rate and liquidity measures:
Repo rate and CRR unchanged at 7.75% and 4.0%, respectively.
SLR cut by 50 bps to 21.5% of NDTL with effect from the fortnight beginning February 7, 2015.
Replace the export credit refinance (ECR) facility with the provision of system-level liquidity with effect from February 7, 2015
Limit under Liberalized Remittance Scheme (LRS) enhanced to US$250,000 per person per year from US$125,000.
FPI debt limit in G-Sec remains unchanged at US$30 bn. However, to incentivize long-term investors, it has been decided to enable reinvestment of coupons in G-Sec even when the existing limits are fully utilized. This could lead to additional space of approximately US$2.4 bn of investments in the G-Sec space.
All future investment by FPIs in the debt market in India will be required to be made with a minimum residual maturity of three years. While G-Sec investment already had this rider, the same will now be applicable also to corporate bonds. Accordingly, all future investments within the limit for investment in corporate bonds, including the limits vacated when the current investment by an FPI runs off either through sale or redemption, shall be required to be made in corporate bonds with a minimum residual maturity of three years.
With a view to providing greater flexibility to both FPIs and domestic participants in the exchange traded currency derivatives (ETCD) market: domestic entities and FPIs will henceforth be allowed to take foreign currency positions in the USD-INR pair up to US$15 mn per exchange without having to establish the existence of any underlying exposure, allowed to take foreign currency positions in EUR-INR, GBP-INR and JPY-INR pairs, all put together up to US$5 mn equivalent per exchange, without having to establish the existence of any underlying exposure, and importers of goods and services: the limit up to which they can take appropriate hedging positions in ETCD markets will be determined as 100% of the higher of the (1) average of their past three years’ imports turnover or (2) the previous year’s turnover, instead of 50% at present.
By Kotak Institutional Equities