E-Books on RBI Policies From Jan 2013- May 2013 EDITOR: ARJUN PARTHASARATHY 1
Table of Content RBI Policies 29 th January 2013 Why RBI will cut repo by 50bps 4-7 Markets should recognize RBI s efforts on growth push 8-10 What RBI says and what it means 11-12 What Does It Mean For Liquid and Income Funds 13-15 RBI should go easy on new bank licenses 16-18 19 th March 2013 March Rate Cut helps Government but not Economy 19-21 Bond Yield Volatility is Temporary 22-23 3 rd May 2013 RBI Shows its Dovish Stance Despite Hawkish Statements 24-25 Bond Yields Headed Down 26-27 2
RBI Policies Jan 2013 May 2013 3
RBI Policies 29 th January 2013 Why RBI will cut repo by 50bps RBI is widely expected to cut the repo rate by 25bps in its policy review on the 29 th of January 2013. The rate cut will be the first in calendar 2013 and the second in nine months after its last rate cut in the April 2012 policy where it cut rates by 50bps. RBI had guided markets for rate cuts in January 2013 in its December 2012 policy review. RBI is more likely to cut the repo rate by 50bps rather than the 25bps cut expected by the markets. The reason for a 50bps cut by the RBI is the positives of the fiscal consolidation measures adopted by the government. The government recently allowed oil companies to raise prices of diesel to reduce their under recoveries and this move is expected to bring down the subsidy bill of the government by 50% in 2013-14. The government is also committing itself to lowering the fiscal deficit in 2013-14 by lowering expenditure and increasing tax revenues. The government is likely to project a fiscal deficit of below 5% of GDP in the 2013-14 budget in February 2013. RBI firmly believes that high fiscal deficits (5.9% of GDP in 2010-11 and 5.3% of GDP in 2012-13) is a major reason for rising inflation expectations. WPI (Wholesale Price Inflation) Inflation was trending at over 9% levels in 2011 before coming off to 7.25% levels in 2012. High fiscal deficit was seen as a major contributor to high inflation in the economy. 4
The rise in administered prices of fuel will result in pushing up prices in the economy in the near future. However once the pass through of global oil prices into the economy is complete, the dynamics of inflation expectations will change. Inflation will then be directly correlated to the behavior of oil prices globally and all reports on global oil prices indicate stability and not sharply rising prices as US is expected to import less and less of oil in the coming years. RBI will choose to look at the longer term benefits of fiscal consolidation through higher prices of administered items such as fuel than the shorter term effects of higher prices in the economy. RBI will be well supported by weak economic data if it cuts the repo rate by 50bps. IIP (Index of Industrial Production) growth is just 1% in the April-November 2012 period while forecasts for automobile sales have been revised to almost 0% levels by the industry body. Export growth is down 5.5% in the April-December 2012 period indicating the weakness in global 5
economies. India s GDP growth is forecast at 5.8% for fiscal 2012-13 against growth levels of 6.5% seen in 2011-12 and 8.4% seen in 2010-11. RBI has been putting off rate cuts after the repo rate cut of 50bps in April 2012 on the back of worries of poor government policies on fiscal consolidation and suppressed inflation in the economy due to fuel subsidies. Inflation has been in the 7.2% to 8% range in 2012 and has refused to come off despite sharp slowdown in growth. The fact that the government is trying to address RBI s worries is positive for rate cut expectations. RBI will cite the need to sustain economic growth that will suffer in the short term on the lack of government spending as the government looks to bring down its deficit. RBI will reinforce its qualitative growth objective (growth sans inflationary pressures) by cutting rates by 50bps and telling the government that it is appreciative of its efforts on fiscal consolidation. RBI will also tell the government to continue its efforts on bring down subsidies and other wasteful expenditure and that the central bank will then help the cause by easing policy rates further. Markets will do well to position for a 50bps cut on the 29 th of January 2013. 6
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Markets should recognize RBI s efforts on growth push RBI policy actions for fiscal 2012-13 include repo rate cut of 75bps, CRR (Cash Reserve Ratio) cut of 75bps and SLR (Statutory Liquidity Ratio) cut of 100bps. In addition to policy rate cuts, the central bank has added Rs 130,000 crores of liquidity into the system through bond purchases. On a daily basis RBI is lending around Rs 80,000 crores to Rs 100,000 crores to banks for their daily liquidity requirements. An impartial observer will look at RBI actions as a pro growth stance by the central bank throughout fiscal 2012-13 though the markets have only focused on the repo rate. The total liquidity infusion by the RBI into the system in 2012-13 amounts to around Rs 245,000 crores excluding LAF (Liquidity Adjustment Facility) lending. CRR cut of 75bps has released around Rs 55,000 crores of liquidity while the SLR cut of 100bps has released around Rs 60,000 crores of liquidity into the system. RBI s liquidity infusion coupled with 75bps of repo rate cut at a time when inflation has been trending at 7.25% to 8% range is more than what one could ask for. The government should take note of RBI s monetary easing while markets should be pleased with the latest round of 25bps repo rate cut and 25bps CRR cut. 8
RBI s monetary easing for 2012-13 is yet to show up in economic and monetary aggregates. GDP growth forecast by the central bank is down to 5.5% for 2012-13 against earlier estimates of 5.8% and 6.5%. Bank credit growth at 16% levels as of January 2013 is lower than the 18.7% growth seen at the beginning of the fiscal while broad money supply (M3) growth is down to 13% from 13.7% levels. Bank deposit growth is down from 14.3% levels to 13.3% levels. However RBI s easing has helped arrest a steep decline in growth and monetary aggregates. RBI has been calling CRR cuts, SLR cuts and bond purchases as liquidity boosting measures, which in effect it is. However such measures are a direct form of monetary easing and when done in conjunction with repo rate cuts adds to the growth prospects of the economy. Equity and bond markets have benefitted from the monetary easing policies of the RBI with the Sensex and Nifty higher by 15% since April 2012 and benchmark ten year bond yield down by 60bps. Looking ahead, will RBI oblige markets by reducing repo rates further? RBI s guidance suggests that the central bank is more growth focused than inflation focused. Its assessment of inflation is more benign despite temporary effects of 9
fuel price hike on headline inflation. RBI s has revised down March 2013 WPI (Wholesale Price Inflation) to 6.8% from 7.5% projected earlier. The central bank expects WPI to stay around 7% in the coming fiscal year. RBI is likely to lower the repo rate by 25bps in March 2013 if the government shows a lower fiscal deficit for fiscal 2013-14 in its budget and this repo rate cut will seal its efforts on growth push for this fiscal. Equity and bond markets will welcome the 25bps repo rate cut and CRR cut. The Sensex and Nifty will head higher on positive budget expectations while bond yields will fall on expectations of lower fiscal deficit for 2013-14 and on expectations of a repo rate cut in March. The Indian Rupee (INR) has been a stark underperformer compared to equities and bonds. The INR is down over 5% fiscal year to date largely on the back of a rising CAD (Current Account Deficit) that rose to record levels of 5.4% of GDP in the second quarter of this fiscal. The INR should start performing going forward on expectations of improved economic growth, stable inflation expectations and better government finances for the coming fiscal. RBI has done its bit for the economy and markets should sit up and take notice. 10
What RBI says and what it means RBI uses central bank language in its monetary policy communication. The RBI communicates its policy to bankers, economists, analysts, bond traders and fund managers and hence it does not require to bring down communication to the level of a non financial person. We will attempt to demystify RBI policy language for you to understand clearly what RBI says and what it means. Inflation has peaked: Prices will not rise as fast as it did last year. Inflation will stay sticky at current levels: Prices will rise at the levels at which it is rising now, which is still uncomfortably high. Overall economic activity remains subdued: Jobs are not increasing as investments are held back. Liquidity conditions have remained tight: Banks are still borrowing from us on a daily basis despite us adding Rs 245,000 crores into the system in this fiscal Liquidity is in structural deficit: Banks do not have money but the parallel system money is growing as cash in circulation is increasing and not coming back into the system. Policy stance will support growth: Rate cuts will help improve economic activity but when is a big question mark. 11
Policy stance will anchor inflation expectations: Inflation will be kept on leash but the hold on the leash is weak. Ensure adequate liquidity for credit growth: We want banks to lend to productive sectors but the fact is the productive sectors do not want the money, only the unproductive one require money such as debt laden real estate firms. Monetary policy has space to address growth risks: We will cut rates to push economic growth. Space to address growth risks is limited: Rate cuts will be too insignificant to help growth Growth-inflation dynamics: Growth is falling and inflation is rising because of twin deficits. Twin deficits risks are high: India runs a fiscal and current account deficit and the government is doing nothing about it Outcome of rate cuts: Growth will improve, inflation will come down and liquidity will ease. We fervently hope that this happens but we know it is too much to ask for in one single rate action. Risks to the policy stance: Indian economy and the world economy is a mess and it can worsen further leading to downside risk to growth and upside risk to inflation. Hopefully it will not happen in the near future. 12
What Does It Mean For Liquid and Income Funds The months of February and March are typically tight liquidity months for the system. Demand for funds goes up across the system as banks; corporates and the government look to balance their books for the fiscal year end. Hence the 25bps repo rate and CRR (Cash Reserve Ratio) cut of the RBI will not immediately translate into lower lending rates of banks or lower deposit rates. Banks will in fact raise deposit rates to improve their liquidity profile, as they would not want to be seen as heavy borrowers from the RBI on the last day of March 2013. The liquidity situation eases considerable in April when all the hoarded liquidity in the system is released. April is when deposit rates will tumble and lending rates get reduced. In effect despite positive sentiments of rate cuts, the next two months will see yields on short term instruments such as CP s (Commercial Papers) and CDs (Certificate of Deposits) being pressured on higher demand for liquidity. However markets will pull down yields at the longer end of the curve on expectations of rate cuts in March and on expectations of an easy policy regime in the coming fiscal. The yields on longer maturity bonds will fall on strong demand. What does it mean for investors in liquid funds and income funds? Investors in liquid funds will face volatility in returns over the next two months as demand for liquidity pushes up yields at the short end of the curve while investors in 13
income funds will see returns trending up as bond prices go up on the back of falling yields. In this scenario investors in liquid funds will have to have an investment horizon of at least one month in order to ride out the volatility. Investors in income fund should hold on or add to their investments to take advantage of an expected fall in yields on longer maturity bonds. The yield on one year benchmark CD is around 8.7% while the yield on a ten year corporate bond is also around 8.7%. Investors can expect ten year corporate bond 14
yields to fall and one year CD yields to stay sticky or even trend up marginally over the next two months. Investments can be positioned on the basis of this trend playing out. 15
RBI should go easy on new bank licenses RBI released an interesting Table in its third quarter 2012-13 monetary policy review. Table 1 shows that PSU banks have been the worst performers in the NPA front and their capital adequacy has actually gone down in the June to September 2012 period. The other bad performer is the old private sector bank category that has seen slippages in its bad loans and capital adequacy. RBI has now released draft guidelines on provisioning norms for restructured standard assets and this will hit PSU banks hard. Banks will have to make provision of 5% on restructured standard assets starting April 2013 if the draft guidelines are accepted. The current provisioning norm is 2.75% for restructured standard assets. PSU banks have the highest ratio of restructured standard assets to gross advances with the ratio being 7.34% as of September 2012. The ratio for PSU banks stood at 6.67% as of June 2012 indicating that more assets are being structured every quarter. The ratio could go up if more real estate firms default on loans. The 37% fall in real estate firm HDIL stock price in the week before last is an indicator of market perception of debt levels of leveraged real estate companies. 16
Table 1. Source: RBI The fact that PSU banks are seeing the worst of the bad loan problems raises many questions on the way the banks are being run. The government ownership of the banks does not lend them much credibility in terms of managing risks. Issues of crony capitalism also comes into play while issues of directed lending to problem ridden state electricity boards also affects the risk management credibility of PSU banks. The government has to appoint the right professionals to manage PSU banks and maintain arms length distance in their functioning. This move will then add credibility to the perception of PSU banks in the eyes of investors and rating agencies. 17
The government is trying to push RBI in giving out new banking licenses with daily media reports on what kind of corporates can be given bank licenses. The fact that the government is getting involved in new bank licenses at a time when its own banks are showing the worst performance in the banking sector leads to serious questions on the intentions of the government. RBI will only give out a few licenses based on merits but given the government involvement there will be raised eyebrows on why certain corporates received licenses and certain corporates did not receive licenses. RBI should hold back on bank licenses until the banking sector gets back on track with balance sheets improving. The government should lay off the RBI on the banking license issue. PSU banks are a bad enough example of the government s involvement in the running of the banks. The economy certainly does not need fresh worries of crony capitalism when corporates are given bank licenses. 18
RBI Policy 19 th March 2013 March Rate Cut helps Government but not Economy The headroom for further monetary easing remains quite limited was enough for the Sensex and Nifty to fall by over 1.5% and for the 8.15% 2022 government bond yield to rise by 6bps. The markets are reading the RBI statement as no rate cuts going forward unless there is a fall in food inflation that is trending at 11.4% levels. RBI is spooking the markets with its focus on food inflation at a time when non food manufacturing inflation is trending at multi year lows of 3.8% levels while GDP growth for fiscal 2012-13 is expected at decade lows of 5%. RBI feels it has done enough for the present to address growth issues. The central bank has cut repo rates by 100bps and CRR by 75bps in fiscal 2012-13 and it has bought government bonds of around Rs 160,000 crores (equivalent to 250bps of CRR cuts). RBI is now indicating that it will wait and watch for further signs of growth slowdown to take action on policy rates. RBI guiding for no rate cuts in its 3 rd May 2013-14 annual policy is not positive. Banks will have no inclination to lower lending rates at a time when there is continuous stress on assets due to a weakening economy. Banks will not strive for credit growth given that reduction in Non Performing Assets (NPAs) will be the priority. Banks will buy government bonds, as it will be seen as a safe asset in times of stressed balance sheets. Banks NPAs have risen by 50% in the first none months of this fiscal reflecting the stress on balance sheets due to economic slowdown. 19
The government benefits from banks buying government bonds as it can push through borrowing of Rs 579,000 crores in fiscal 2013-14. However banks buying government bonds will not help the economy in any way unless government bond yields trend down to levels where banks find it more worthwhile to lend to the economy. In short banks have to be discouraged from buying government bonds and that will not happen unless government bond yields fall, economic growth improves and banks become more comfortable on credit. RBIs hawkish tone on further rate cuts suggest that government bond yields will not fall as markets will be reluctant to fund the government at lower levels of yields. Economic growth will not happen as lending rates stay high in the economy while banks will continue to shy away from credit exposures on NPA worries. 20
The question the RBI will now have to ask itself is what purpose will a status quo on policy rates achieve? If the answer is that it will contain inflation expectations leading to a fundamentally stronger economy that can in turn lead to sustainable economic growth, then it is best to keep rates on hold. On the other hand if no rate cuts lead to inflation expectations remaining high and economic growth falling off a cliff then rates should either be pushed up or lowered. Doing nothing does not help. In the meanwhile markets will have created enough volatility to hurt sentiments on the economy. Until 3 rd May 2013 Amen. 21
Bond Yield Volatility is Temporary Bond markets have nothing to look forward except fresh supply of government bonds starting April 2013. RBI has cut repo rate by 25bps as per market expectations but has indicated that it has low headroom to cut rates further. The government has announced a borrowing program of Rs 349,000 in the April- September 2013 period and the RBI has put out the borrowing calendar that shows a weekly borrowing of Rs 15,000 crores. The borrowing will be heavily skewed in the 10-14 year maturity bucket with over 40% of the borrowing being done by issuing bonds in this segment. The market reaction was negative to the RBI s hawkish stance on further rate cuts and yields on the benchmark ten year bond, the 8.15% 2022 bond, moved up by 5bps to trade at 7.91% levels. Bond traders are likely to take the yields on government bonds higher as they empty their books to absorb the fresh bond supply starting in the first week on April. The ten year yield will trend over 8% levels by the end of March from current levels of 7.91%. 22
April will see issuance of new benchmark bonds in the five and ten year segments of the government bond yield curve. The market will be light on positions going into the auctions, as it would have sold off whatever position it is holding in the current benchmark bonds. Bidding for new benchmark bonds will be aggressive and ten year bond yields will fall in the auctions. The RBI annual policy review for 2013-14 is slated for the 3 rd of May and while RBI has indicated that further rate cuts may not happen, the markets will hope for a more dovish stance. RBI will have to set targets on inflation, GDP growth, credit, deposit and money supply growth for fiscal 2013-14 and it will find that any growth target will be difficult to achieve with a tight monetary stance. Investors who have invested in long bond funds on the hope of yields trending down should ride the current volatility in bond yields as this volatility has more to do fiscal year end positioning rather than expectations of a higher interest rate regime going forward. 23
RBI Policy 3 rd May 2013 RBI Shows its Dovish Stance Despite Hawkish Statements The RBI governor Dr. D. Subbarao is saying he is hawkish on rates but his actions suggest that he is dovish on rates. The Central Bank cut the benchmark policy rate, the repo rate by 25bps in its annual policy statement today. The markets were largely expecting a 25bps repo rate cut but it received a scare when the Monetary and Macroeconomic Developments 2012-13 document released on the 2 nd of May 2013 opened with the statement that there is limited space for monetary action in 2013-14. The governor is reiterating that there is limited space for monetary action henceforth but he has not explicitly spelt out the depth of the space. RBI is dovish going by the annual policy forecasts. GDP growth for 2013-14 is placed at 5.7% against government s growth rate of 6.4% and against professional forecasters estimates of 6%. Inflation as measured by the WPI (Wholesale Price Index) is forecast at around 5.5% against professional forecasters estimates of 6.5%. Monetary aggregates estimates of broad money supply (M3) at 13%, deposit growth of 14% and non food credit growth of 15% are close to levels of 13.3%, 13.5% and 13.9% respectively seen in the last fiscal. 24
RBI s growth, inflation and monetary aggregate estimates are on the lower side indicating that the central bank is not seeing any signs of the economy heating up leave alone overheating. In fact RBI sounds pessimistic on economic growth and benign on inflationary expectations. RBI is concerned on the current account deficit (CAD), as it believes that the right level for the country is 2.5% of GDP. CAD is estimated at around 4.5% of GDP for 2013-14 though it could fall more if global oil and gold prices continue to stay down. However the fact the CAD is being financed fully by capital flows reduces part of the worry of a high CAD but this kind of financing of the CAD leaves the economy vulnerable to external shocks. The central bank is appreciative of the government lowering its fiscal deficit to levels of 4.8% of GDP from 5.2% of GDP seen in the last fiscal. The RBI policy stance for 2013-14 is to address accentuated risks to growth, guard against inflation pressures and manage liquidity to ensure adequate credit flow in the economy. In the same breath the central bank is saying there is limited space for monetary action in its guidance statement. RBI is clearly keeping market expectations low on further policy actions but going by its estimates for growth, inflation and monetary aggregates, there is high probability of more rate cuts going forward. 25
Bond Yields Headed Down www.inrbonds.com RBI s 25bps repo rate cut in its 3 rd May 2013 annual policy statement is likely to spur a bond market rally going forward. Bond markets will start expecting at least one more repo rate cut in the next couple of months and start taking down bond yields. Ten year benchmark bond is trading at levels of 7.75% and yields will trend down towards 7.50% levels in the coming months. Falling government bond yields will lead to corporate bond yields coming off. The reason why bond markets will build in one more rate cut from hereon is RBI s policy stance, that is primarily to address accentuated risks to growth. The incoming economic data has not been very positive with April 2013 manufacturing growth coming in at a seventeen months low. April four wheeler and two wheeler sales have shown negative growth across manufacturers. On the global front central banks from the ECB that cut rates by 25bps on the 2 nd of May to Bank of Japan are worried on lack of growth in their economies. The US Federal Reserve has reaffirmed its monthly bond purchases of USD 85 billion on the back of sluggish growth worries. RBI s own forecast of GDP growth at 5.7% is lower than government s forecast of 6.4%. The central bank does not see much scope for growth this year and given its commitment to growth, it is likely to cut the repo rate in its forthcoming policy review. On the inflation front, RBI s forecast at 5.5% for this fiscal is well below the average of 7.3% seen in the last fiscal. Weak global commodity prices with oil 26
prices down over 10% over the last few months will help bring down inflation expectations. Liquidity conditions are more positive than it looks. Banks are borrowing around Rs 80,000 crores from the RBI on a daily basis but this is largely due to high cash balances of the government. Government spending will improve system liquidity going forward. Investors should position their fixed income portfolios for further fall in bond yields. Investors who do not invest directly in the bond markets should look at long term gilt and income funds and short term income funds as these funds are the best positioned to capture the fall in bond yields. Dynamically managed bond funds that are running positive views on yields will also benefit from falling bond yields. The risks to a positive view on bond yields are external shocks, rising commodity prices and political instability. In the current environment of falling growth expectations and stable inflation expectations, a positive bond yield view is a risk worth taking. 27