Prolonged pause? RBI retains rate & stance, for now

By: | Published: December 6, 2018 4:17 AM

SLR to be cut 25 bps each for 6 quarters from Q4, increased OMO frequency in Q4, new retail/MSME loans linked to external benchmark.

The Sensex and Nifty ended 0.7% and 0.8% lower respectively, largely owing to a fall in overseas markets.

The Reserve Bank of India (RBI) on Wednesday left the repo rate unchanged at 6.5% and stayed the course to ease the systemic liquidity as most analysts expected, but refused to open a special liquidity window for non-banking finance companies. It however, surprised some by not changing the policy stance from ‘calibrated tightening’ to ‘neutral’ although the assorted risks that prevailed during the previous policy review have largely dissipated and the latest data-points have rather abruptly thrown up a new mix of more benign inflation and slower economic expansion.

In the fifth bi-monthly policy statement for this fiscal, the Monetary Policy Committee (MPC) substantially lowered its retail inflation projection to the range of 2.7-3.2% for the second half of the current fiscal from 4% previously, but it bode its time to assess the inflation outlook better. On growth, it retained the earlier estimates, appearing more sanguine than most analysts.

The MPC did not say it in as many words — even as it left a dovish tone and signalled a prolonged pause prompting analysts to rule out a rate hike this fiscal — but in his customary post-policy address to the media later, governor Urjit Patel hinted at the possibility of the next rate action being even a cut. He, however, stressed the call would be intently data-dependent.

The MPC cited concerns over the durability of low food inflation that ‘surprised on the downside’. High volatility in crude oil options which is at odds with a 30% drop in
prices since last policy was also taken note of.

The committee’s tone was positive for the bond market and so was deputy governor Viral Acharya’s assertion that the central bank will increase the frequency of open market operations (OMOs) that will take place alongside long-term repo operations in the March quarter.

Benchmark bond yields fell to 7.41% before closing at 7.44%, down 13 basis points (bps) from the previous close of 7.58% and the lowest level since April. The Sensex and Nifty ended 0.7% and 0.8% lower respectively, largely owing to a fall in overseas markets.

The RBI also decided to link banks’ lending rates on new retail and MSME loans with external benchmarks. The move, analysts said, would improve transparency in loan pricing by banks as the existing benchmarks, especially the base rate, have not allowed a full transmission of the benefits of decline in cost of funds for banks to borrowers. However, this could lead to higher volatility in banks’ profitability, unless they are able to raise floating rate deposits linked to external benchmarks and more frequent reset of EMIs.

Beginning Q4FY19, the statutory liquidity ratio for banks will be lowered by 25 basis points in each quarter over six quarters to 18% in a move that would align it with the liquidity coverage ratio, the RBI said. Though this could provide some additional leeway for all banks to lend, analysts said private banks will benefit more, as their SLR holdings are closer to regulatory requirements compared with state-run banks. Notwithstanding the already high credit-deposit ratio, the proposed cut raises the ability of private banks to deploy their deposits in higher-yielding loan assets. Public sector banks on the other hand will need to shore up their capital position to pursue credit growth and benefit from the lower SLR requirements, they added.

Economic affairs secretary Subhash Chandra Garg said the government noted RBI’s decision to maintain the repo rate and that the “policy stance probably required calibration”. The RBI’s decision to reduce the SLR will have some implications for government securities. “However, the momentum created by the reduction in oil prices and reversal of foreign flows has resulted in further moderation of yields post policy announcement” Garg added.

Estimating an overall liquidity deficit of Rs 1 lakh crore, Bank of America Merrill Lynch recently said the central bank may have to inject another Rs 1.6 lakh crore into the banking system through OMOs during Q4FY19. RBI has lined up a plan for a Rs 40,000 crore OMO infusion in December.
The MPC cited concerns over the durability of low food inflation that ‘surprised on the downside.’ High volatility in crude oil options which is at odds with a 30% fall in prices since last policy was also taken note of.

The retail inflation has remained below the RBI’s medium-term target of 4% in the last three months and fell to a 13-month low of 3.3% in October largely due to a big, broad-based fall in food prices that pushed the food group with 40% weight in consumer price index (CPI) into a deflation. But Patel highlighted a possible reversal in food deflation, crude price volatility and possible Centre-state fiscal slippages as upside risks to the inflation trajectory. “On balance, the MPC was of the view that incoming data will help ascertain the durable nature of recent inflation softening and allow better judgment on future policy actions,” he said.

As for growth, despite the Q2 rate for GDP coming in a lower-than-expected 7.1%, the MPC retained its projection for gross domestic product (GDP) for 2018-19 at 7.4% (7.2-7.3% in H2) and forecast a growth rate of 7.5% for the first half of 2019-20, with risks somewhat to the downside. It said that output gap has practically been closed. Even as there is a concern over a possible deepening of the rather unexpected slowdown in private consumption in Q2 – the still-to-be-fully-resolved liquidity problem in non-bank space and low rural income are expected to hit consumer demand in H2 –, the MPC opined that the decline in crude prices could boost corporate earnings prospects and private consumption. Acharya pointed out that non-food bank credit growth at 15.3% remained higher than growth in the nominal GDP.

Although the MPC said lower rabi sowing, financial-market volatility and rising (global) trade tensions could dent demand, it expected the acceleration in investment activity – which many analysts say is driven almost entirely by public expenditure — could be sustained and added that increased capacity utilisation in the manufacturing sector might be signalling new capacity additions.

In the context of the sustained call from the government for a special liquidity window for non-banking finance companies, Acharya said:“The Reserve Bank is guided, by and large, by the principle of addressing system-wide liquidity. It also stands ready to be the lender of last resort, but that is provided conditions warrant that sort of an extreme measure.. in our assessment there is no such necessity at present.”

Patel said there was no need for a cut in banks’ cash reserve ratio (CRR) as the central bank has other policy instruments at its disposal to ease system liquidity. The CRR at present stands at 4% of banks’ net demand and time liabilities, or deposits.
Permitting non-residents to hedge their rupee interest risk will provide the much-needed fillip to the rupee interest rate derivative market, SBI chairman Rajnish Kumar said. “Allowing non-residents to participate in the OIS market for non-hedging purpose will also broad-base participation.”

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