After the surprise rate cut on January 15, the RBI maintained status quo at its sixth bi-monthly policy review. The outcome was widely anticipated as there was little reason for a follow-up action in the absence of any incremental information over the last 2-3 weeks.
However, RBI announced measures on liquidity and took steps for improvement of financial market structure, along with regulatory development for the banking sector.
To highlight, the 50-bps SLR cut will provide approximately R45,000-crore potential liquidity, thereby enhancing the incremental lending ability of the banking sector.
Besides, banks would get the flexibility to issue non-callable deposits with differential interest rates and a relaxation in the dispensation to NPAs with respect to sale of such assets to ARCs. In addition, the economy would gain from easing of DCCO restrictions for stalled projects, which require a change in ownership and revival structure. On financial markets, permitting stock exchanges to introduce longer-dated IRF contracts, liberalising fx remittance limits and introduction of safeguard measures for protecting downside risks of FDI investors are steps in the right direction.
The only area where RBI turned cautious is in the corporate debt market, where investments by FPIs have been discouraged at the shorter end of the yield curve. An economy like India that is moving on the path of recovery and offering a relatively attractive yield has emerged as an attractive investment destination in a low interest rate global environment. However, with G-Sec investment limit being completely utilised, most of the recent debt flows where in corporate debt, especially in the short dated papers.
Such investments are typically unhedged and stoke volatility in both interest rate and currency markets (a la Jul-Aug 2013) when the underlying carry position is unwound. Hence, the RBI imposed tenor restrictions on corporate debt investments and also disallowed incremental investment in short maturity liquid/money market MF schemes.
These restrictions were partially compensated by allowing reinvestment of coupons in G-Secs even when the existing G-Sec investment limits are fully utilised — this will imply a slow and steady increase in the G-Sec investment limit without an actual hike.
What about monetary policy now? Has RBI turned cautious after taking the first leap of faith? The answers would depend upon both the short- and long-term inflation trajectory, along with global financial market conditions.
To elaborate, soft global commodity prices and efficient management of the food economy by the government shall continue to impart disinflationary impulses over 2015-16. With subsidy burden likely to get curtailed through pricing and efficiency gains in disbursal, the government could enhance the quality of its balance sheet by diverting expenditure towards productive capex, which will be likely aided by an aggressive divestment agenda. This will promote crowding in of private investment, which continues to suffer from slackness.
Quality fiscal consolidation and persistence of economic and administrative reforms will help in lowering structural inflation in the medium term. I expect the upcoming Budget, designed on such contours, to provide medium term cues.
In the short term, I expect CPI to remain range-bound around 5.5%, lower than RBI’s January 16 target of 6%, thereby providing comfort.
In my opinion, this will open up space for incremental 50-75 bps of cumulative monetary easing without diluting the need for having a real monetary policy rate of 1.5-2.0%. This incremental monetary easing is likely to get front loaded due to two reasons. First, considering the transmission lags, faster monetary easing will be more efficient in reviving economic growth. Second, with the US Fed expected to start raising interest rates in July-September 2015, a direct confrontation with its monetary policy trajectory can be best avoided from the perspective of stability in domestic financial markets.
By Shubhada Rao
The writer is chief economist at YES Bank