Monetary Policy Review : April 16

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1 April 5, 2016 Monetary Policy Review : April 16 On expected lines, the RBI in its first bi-monthly Monetary Policy announced 25 bps cut in repo rate from 6.75 % to 6.5%. It also announced measures to address the prevailing tight liquidity conditions in the system. Liquidity Measures Minimum daily maintenance of the cash reserve ratio (CRR) has been reduced from 95% of the requirement to 90% w.e.f 16, April 16. CRR unchanged at 4% of net demand and time liabilities (NDTL). Progressively lower the average ex ante liquidity deficit in the system from 1% of NDTL to a position closer to neutrality Narrow the policy rate corridor from +/-100 basis points (bps) to +/- 50 bps. Consequently MSF rate to be 7% and reverse repo to be 6% (previously the MSF rate was 100 bps above repo rate and reverse repo rate was 100 bps lower than repo rates). Impact of these measures 1. The lowering of the policy corridor is useful especially when banks are borrowing in the market. Today with the MSF being 100 bps higher than the repo rate, the cost of funds has increased. By lowering the MSF rate, in effect the call rates would tend to move down. Further banks with surplus funds can earn more through the reverse repo window. 2. The liquidity issue with banks caused by lower growth in deposits has been addressed partly by lowering the minimum daily balances to be held under CRR. Banks will gain to the extent of around Rs 20-21,000 cr on this count. However, this is lower than the impact of a CRR reduction of say 0.5% which would have released around Rs 50,000 cr. 3. It will be interesting to see whether or not banks lower their deposit rates given that there has been a slowdown in growth in deposits in FY16. This will also determine the movement in the MCLR that will be announced in May by all banks. Banks are likely to selectively lower deposit rates for lower tenures given the difference in rates on small savings and bank deposits with maturities for 5 years. 1

2 Policy Stance and Rationale Inflation was along the projected trajectory and the target set for January 2016 was met. CPI Inflation for is expected to be around 5%. However, there are uncertainties to this target emanating from unseasonal rains, monsoons, low reservoir levels, and rise in commodity prices, especially oil. Also, the implementation of the 7th pay commission could push inflation through direct and indirect effects (could push it up to 6%). Growth in value added is to be 7.6% for the coming year. Implication The RBI will be tracking inflation closely and will not be in a hurry to lower rates further. By keeping a target of 5%, it is implicit that it will not fall below this number to warrant more aggression in policy. CARE Ratings View By restricting the repo rate cut to 25 bps, the RBI has reiterated that it continues to adopt a cautiously accommodative monetary policy stance given the prevailing economic uncertainties. Moreover, with banks moving to the Marginal Cost of Funds based Lending Rate (MCLR) system since 1 April 16, the lending rates of banks have already seen a decline (estimated to be 25 to 50 bps), warranting a lower rate cut by the RBI. The liquidity measures announced will help ease the liquidity conditions in the system and well as help in the transmission of lower interest rates. We expect the RBI to cut repo rates by another 25 bps in Some Significant policy announcements A fresh discussion paper on large exposures of banks is to be brought out by April and based on the feedback will be formalized for implementation in This will divert companies to the market and the corporate bond market will benefit from this measure. IRFs for money market instruments are to be introduced. This will be another instrument available for hedging and taking positions in the financial markets which can provide a boost to bond markets. However it must be pointed out that the earlier measures for bringing in IRFs have had very limited success. Draft guidelines may be expected for issuance of Commercial Paper. There will be a comprehensive review of guidelines with the objective of, inter alia, strengthening disclosure requirements by issuers of CPs, reviewing the role of issuing and paying agents (IPAs) and putting in place an information dissemination mechanism. The RBI reference rate would move towards being based on actual trades rather than a poll from May onwards. Impact of Credit Policy : April

3 Concept note on peer to peer lending may be expected from the RBI by April end which will form the basis for a detailed structure. In case of MSMEs, the RBI will lay down a framework by September 2016 for accreditation of credit counsellors who can act as facilitators for entrepreneurs to access the formal financial system with greater ease and flexibility. Credit counsellors will also assist MSMEs in preparing project reports in a professional manner which would, in turn, help banks make more informed credit decisions. Contact: Madan Sabnavis Kavita Chacko Chief Economist Economist madan.sabnavis@careratings.com kavita.chacko@careratings.com Disclaimer This report is prepared by Credit Analysis &Research Limited (CARE Ratings). CARE Ratings has taken utmost care to ensure accuracy and objectivity while developing this report based on information available in public domain. However, neither the accuracy nor completeness of information contained in this report is guaranteed. CARE Ratings is not responsible for any errors or omissions in analysis/inferences/views or for results obtained from the use of information contained in this report and especially states that CARE Ratings has no financial liability whatsoever to the user of this report. Impact of Credit Policy : April

4 Appendix Economic Assessment: Global Global economic activity has been rather stagnant in the last 2 months. Perceptions of downside risks to recovery in some advanced economies (AEs) have eased. Major emerging market economies (EMEs) continue to be faced with weak demand & growth, inflation pressures and tight financial conditions. World trade remains subdued mainly due to falling import demand from EMEs. In the US, consumer spending is supported by strengthening labour markets, but falling exports dragging down economic growth and outlook for the same. Euro region economy activity is being supported by extremely accommodative monetary policy and low energy prices. Uncertainties abound here owing to the migrant crisis, stress in banking sector and possible Brexit. Japan s economy has slowed in Q1 2016, weighed down by weak consumer spending, business investments and exports. China - sluggish industrial production, contracting exports, capital outflows and substantial excess capacity in factories and the property market remain formidable headwinds, despite significant monetary and fiscal policy stimulus. Global financial markets have recouped the losses suffered in at the beginning of the year. From mid-february, a firming up of crude prices buoyed market sentiments. Equity markets have rallied with China reducing reserve requirements, the ECB expanding accommodation and the Fed not raising interest rates and providing a dovish guidance. The US dollar has retreated following the Fed move, while the euro and yen appreciated following the exceptional monetary policy accommodation. EME currencies have also appreciated following the return of foreign inflows into their debt and equity markets. Gold prices have risen (16% in Q1 2016) on safe haven demand and commodity prices, including oil, have picked up, though they remain low. Economic Assessment: Domestic In case of agriculture, despite the unfavorable weather conditions, rabi foodgrains production is estimated to be have increased over a year ago, compensating for the losses in kharif output. Fertilizer production has picked up and horticulture as well as allied activities has remained resilient. Impact of Credit Policy : April

5 Industry Improvements in manufacturing in H , helped by lower input costs, boosted overall industrial output. However, since November, manufacturing output has been shrinking, causing industrial output to be flat. Capital goods production fell into deep contraction since November. Weak demand and competition from imports have muted the capex cycle Services sector activity expanded steadily through the year, with trade, hotels, transport, communication and public administration, defence and related services turning out to be the main drivers in H2. CPI dropped significantly in Feb, after rising for 6 consecutive months, helped by a decline in vegetable and pulses prices. Liquidity conditions, which had tightened since mid-december, worsened owing to accumulation of cash balances by the Government, unusually heightened and persistent demand for currency, a pickup in bank credit and decline in deposits. The Reserve Bank undertook liquidity operations by way of additional liquidity injection through finetuning variable rate repo auctions in tenors ranging between overnight and 56 days. FCNR(B) deposits and associated swaps undertaken in September 2013 are expected to mature starting September this year. These swaps are fully covered by the Reserve Bank s forward purchases. Although, no downward revision to the GDP growth estimate of 7.6% in FY17 have been made, its points to the downside risk to this estimate by way fading advantage of low input cost to manufacturing, continued corporate stress, banking stress and weak global demand and growth. Impact of Credit Policy : April