RBI Monetary Policy: Four key things to watch for rate cut transmission

Published: June 4, 2019 7:16:14 PM

The second Bi-monthly policy meeting is largely expected to deliver 25bps rate cuts amid lower CPI prints and slowdown in Q4 GDP.

RBI statements have averaged 3,084 words in the post-inflation targeting regime (Reuters File photo)Market participants are expecting RBI to move to surplus banking system liquidity stance to improve transmission which will eventually benefit the real economy.

By Kunal Shah

The second Bi-monthly policy meeting is largely expected to deliver 25bps rate cuts amid lower CPI prints and slowdown in Q4 GDP. MPC members’ meets when global oil prices have dropped by 15% since last policy, Core CPI print is 75bps lower and global and domestic growth have slowed down. The stronger election mandate also comforts on reform agenda. MPC members will also discuss possibilities of changing liquidity framework. Market participants are expecting RBI to move to surplus banking system liquidity stance to improve transmission which will eventually benefit the real economy, however for that to happen we believe the current corridor of 25bps (repo and reverse repo rate) will not be sufficient.

Widening of corridor to at least 50bps and moving liquidity to surplus mode can help achieve the transmission aim. The inflation projection for the year are between 3.5%-4% giving enough room for MPC to cut at least 50bps to support sub-par growth. The revival of investment will be key to support long-run supply and hence lower prices in the medium term.

Bond markets have already rallied to 7% post-election result and global meltdown in yields. Swap markets are already pricing in 50bps of easing in next 3-6months. Overall the supportive global monetary backdrop and need to revive domestic growth should pave the way for MPC to ease aggressively in next few policies; the expansionary policy could be engineered either by lowering rates aggressively or liquidity infusion with smaller cuts.

For the effective transmission of RBI rates to lending rates following things need to be watched;

The width of LAF corridor and banking system liquidity.

Fiscal situation to avoid crowding out.

Alignment of small savings rate to government bond yields.

NBFCs liquidity situation.

From the bond market point-of view the yields should trade in the range of 6.70-7.10% if MPC eases rates by 25-50bps. Lower global yields and oil prices have given fillip to bond prices. Market participants should be watchful of governments stand on small savings rate, banks deposit growth rate, because as seen in the past the yields below 7% is difficult to sustain if other markets rates remain sticky irrespective of policy rates.

The author is CFA, Fund Manager – Debt, Kotak Mahindra Life Insurance Co. Limited. The views expressed are the author’s own.

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