3rd Bi-Monthly Monetary Policy Review, 2016-17 Kotak Mutual Fund Update as on 9 th August 2016 1
Monetary Measures: Key Rates Measures CRR Unchanged at 4.00% Reverse Repo rate Unchanged at 6.00% (affixed at 50 bps below repo) Repo Rate Unchanged at 6.50% MSF Rate Unchanged at 7% (at 50 bps spread over repo) Bank Rate Unchanged at 7% (at 50 bps spread over repo) SLR Unchanged at 21.25% Marginal Cost based Lending Rate(MCLR) adds an additional 25 bps downward pressure on interest rates 2 Source: RBI
Transmission of rate cuts is key RBI s key concern - slow transmission of rate cuts Median decrease in base rates by banks 60 bps RBI s rate cut since Jan-15 150 bps Banks rationale - Average borrowing cost is still high RBI s methodology for base rate calculation as per the marginal cost of funds has come into effect from 1 st April 2016 Marginal cost of fund = incremental deposit costs. 3 Source: RBI
MCLR Simplified Premium on the tenure of lending Operating Cost of running a bank Negative carry on account of CRR; Deposit rates, return on net worth + + + Risk on lending for longer terms Competitive efficiency of running a cost effective business Capital cost of keeping cash idle with RBI Policy rates, liquidity, competition impacts here = (Marginal Cost of funds based Lending Rate) MCLR for 1 year rate 4 Source: RBI
Interpreting the Central Banker s Stance RBI s Wordings The prospects for inflation excluding food and fuel are more uncertain; if the current softness in crude prices proves to be transient and as the output gap continues to close, inflation excluding food and fuel may likely trend upwards and counterbalance the benefit of the expected easing of food inflation. Easy liquidity conditions are already prompting banks to modestly transmit past policy rate cuts through their MCLRs and pro-active liquidity management should facilitate more pass-through. Our Interpretation Some pressure in core inflation may be visible Rate transmission is happening due to liquidity The Reserve Bank intends to continue with this strategy, with the intention of closing the underlying liquidity deficit over time so that the system moves to a position of structural balance. As regards the management of the imminent FCNR(B) redemptions, the Reserve Bank has been frontloading liquidity provision through open market operations and spot interventions/deliveries of forward purchases. The Reserve Bank will continue with both domestic liquidity operations and foreign exchange interventions that should also enable management of the FCNR(B) redemptions without market disruptions RBI will continue with OMO purchases to keep the liquidity at balanced levels 5
Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Inflation Base effect visible 12.00% 10.00% 8.00% CPI Core CPI 6.00% 5.8% 4.00% 4.5% 2.00% 0.00% Source: MOSPI Headline CPI inflation remained unchanged in the June month at 5.8%YoY, Vs 5.76% in May-16 Internals are positive: The pace of sequential increase in CPI index moderated to 0%MoM in seasonally adjusted terms compared to 0.9%MoM and 0.8%MoM increase in last two months. The core CPI inflation moderated for second consecutive month to 4.5% vs. 4.7% the preceding month The higher food inflation hasn t generalized to broader group 6
Focus on liquidity will be the game changer From liquidity deficit to liquidity Positive 1500 1000 Total Liquidity 500 0-500 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16-1000 -1500-2000 -2500 Total Liquidity in INR bn -3000-3500 Source: KMAMC estimates 7
FCNR-B Redemption Pressure - But not Stress What is FCNR-B? In Sept 2013 when the rupee was under pressure, banks raised $25 billion through Foreign Currency Non Resident (FCNR) deposits and another $9 billion through foreign currency borrowings and swapped the same with RBI. What s the Issue? The $25 billion, most of which was linked to borrowed funds, will be due between September and November. That amounts to sizeable outflow pressure on exchange rate. IS RBI Prepared? While RBI acknowledged that volatility may emerge, their foreign exchange reserves which now stand at a comfortable $360 billion is more than sufficient. As such, the RBI can sell dollars into the market to ease any shortage of foreign exchange 8 8
Monetary Policy Committee (MPC) - Balanced Structure - transition in Power Next policy to probably be decided by MPC MPC is to be a six-member panel It will feature three members from the RBI (Governor, Deputy Governor & another official) Another three independent members to be selected by the Government. MPC will meet 4 times a year to decide on monetary policy by a majority vote If there s a tie between votes, the RBI governor gets the deciding vote Government and RBI members on the MPC brings accountability Government would have to restrain deficit & RBI would need to manage inflation 9
Debt Market Outlook Long Term Curve : In the near term we expect market (10 year Gilt) to be range bound by 5-10 bps. We believe the positives (good monsoon, OMO, inflation trending downward, GST ) far outweigh the negatives (potential fed rate hike, temporary spike in inflation, uncertainty on account of FCNR redemptions) There is possibility of 25-50 bps repo rate cut in rest of FY 17 if Inflation remains below RBI s target range of 5 % In addition, the RBI s stated intention to reduce liquidity deficit to zero implies an OMO of around Rs 1.50-2 trillion in FY 17 which is positive for bonds. For above stated reasons, we believe that the current 10 year gilt may even touch 6.90% over the next 6 months 10
Disclaimers & Risk factors The information contained in this (document) is extracted from different public sources. All reasonable care has been taken to ensure that the information contained herein is not misleading or untrue at the time of publication. This is for the information of the person to whom it is provided without any liability whatsoever on the part of Kotak Mahindra Asset Management Co Ltd or any associated companies or any employee thereof.we are not soliciting any action based on this material and is for general information only. Mutual Fund investments are subject to market risks, read all scheme related documents carefully. 11