The 50 bps rate cut by RBI may not be the end of the easing cycle, and there may be more in FY16
The decision to cut the repo rate by 50 basis points is a bold and pragmatic move. At SBI, we had pencilled in a 25 bps rate cut, but had anticipated an outside chance of a further 25 bps. This is the first standalone 50 bps cut in repo rate since April 2012. This cut has been conditioned upon the fact that there is a need to look inwards for complementing external demand with domestic demand and prevent any further buildup of domestic excess capacity.
The good thing is that this rate cut may not be the end of the easing cycle, and there may be more in FY16. Consider the following. RBI in its latest annual report indicated that the risk-free natural real interest rate for Q4FY15 ranged from 0.6% to 3.1% (it is time-varying). This is different from 1.5% to 2% that RBI has earlier set out. The natural rate of interest is the rate at which real GDP is growing at its trend rate and inflation is stable. But the time-varying natural rate for India has moved in the range of 0.5% to 4% and seems to have declined since 2010 to about 2% now.
Though RBI has pointed out that the estimation of the natural rate of interest is sensitive to the underlying model, choice of variables, assumptions used for approximating potential output, the representative measure of inflation expectations and even inflation target (6% vis-a-vis 4%), yet the range it has provided for Q4 is highly contentious and needs debate.
If GDP is lower than predicted, the estimate of the natural rate is lowered. Given that RBI has actually lowered the GDP forecast in the current fiscal, the real rate of interest currently is possibly lower than the lower band at 1.5%, indicating room for RBI to cut repo rate further from 6.75% (even after assuming inflation at 5-5.5% )! Interestingly, we also expect that RBI revised projection of 5.8% in January 2016 may have an upward bias, thus keeping the option open for more rate cuts as growth considerations increasingly take centre-stage.
Elsewhere, the policy has a number of positive surprises. In order to support the government initiative of Housing for All by 2022, RBI has indicated for lower risk weights for low-value housing loans. This is a welcome move and will give necessary fillip to the housing sector. Further, as around 70% or even more of home loan portfolio of large PSBs comprises of affordable housing, this measure will help banks transmit interest rates in a better manner. A 10% reduction in risk-weight will lead to release of a minimum R4,200 crore of capital for banks.
To align HTM cap and SLR, RBI has decided to bring down the ceiling on SLR securities under HTM from 22% to 21.5% with effect from the fortnight beginning January 9, 2016. Thereafter, both the SLR and the HTM ceiling will be brought down by 0.25% every quarter till March 31, 2017. Assuming the deposit growth is around 11.6% for the next one year, this will release additional funds to the tune of R1,08,000 crore.
RBI will henceforth set the limits for FPI investment in debt securities fixed in rupee terms. The limits for FPI investment in central government securities will be increased in phases to 5% of the outstanding stock by March 2018, resulting in additional investment of R1,20,000 crore in central G-Sec. Now the current outstanding stock of central government securities is R43,62,600 crore. At the existing level, the FPI limit of R1,53,500 crore is already 3.52% of the outstanding stock. The measure links the government’s rupee external liability to the Medium Term Fiscal Policy statement under FRBM. Thus, the measure is a step closer for the formation of Public Debt Management Agency as it sets the limit on extent of possible borrowing from external sources in rupee.
While on the one hand the reduction in SLR and HTM will reduce LCR pressure, on the other hand increase in FPI limit both in G-Secs and SDL will create addition demand for SLR securities. But the additional demand would be eaten away by cut in SLR to some extent.
There is also a major thrust by RBI to allow corporates to raise rupee-denominated bonds abroad with no end-use restrictions. This will ease the pressure on dollar external liability from ECB component going forward.
As India is going to convergence the current IND-AS with IFRS with effect from April 1, 2018, RBI has also recommended the ministry of corporate affairs a roadmap for the implementation of IND-AS by banks and NBFCs.
The IFRS convergence process will involve significant challenges for the banking system in general. Banks would need to upgrade their infrastructure, including IT and human resources, to face the complexities and challenges of IFRS.
Transmission of rates has already started to happen, with SBI cutting base rate by 40 bps to 9.3%, the lowest in the industry. It is clear that in the coming days there will be more transmission. Interestingly, the current incremental credit growth numbers indicate that there is a substantial less credit growth despite banks having reduced their base rates in the range of 30-65 bps in 2015, prior to the repo rate cut yesterday. It remains to be seen how consumption demand perks up after this move by RBI.
The author is chief economic advisor, SBI. Views are personal