RBI to wait and watch how monsoon, inflation turn out: HDFC Bank

While the RBI is likely to highlight the risk of rise in crude prices, it could be reiterated that on an average the import basket price for crude should remain subdued and comfortable.

-US Fed is unlikely to raise rates in its June meet, the RBI is likely to wait for its guidance on rate trajectory and reiterate that global risks remain more or less balanced for now.

- Assuming a normal monsoon, a restrained hike in the minimum support price (MSP), and only partial implementation of Seventh Pay Commission recommendations, the inflationary pressures are likely to remain muted.

Clarifications on Liquidity management:

- The critical part of the statement could be clarification and guidance on liquidity infusion.

-Hope that the RBI will shed light on the following questions.

1.What exactly does the RBI mean by liquidity neutrality?

2.How will the seasonal fluctuations in liquidity drivers like government spending (the analogue is liquidity draining cash balances with the RBI) affect its strategy?

3.What exactly is the time-frame over which the RBI will reach this ‘neutral regime’?

The report also analyses the quantum of open market operations (OMOs) that are required to reach a ‘liquidity neutral’ regime.

HDFC Bank has suggested the following approaches that are likely to be taken in terms of OMOs:

Approach 1: With a simple model matching money supply and demand in the economy, the RBI could be targeting around 16 percent growth in reserve money for FY17.

This is assuming income elasticity of money demand at around 1.4 for India (1 percent increase in income requires 1.4 percent increase in money supply).

Thus, with a likely real GDP growth of 7.8 percent in FY17 and 5 percent inflation, the RBI could seek to create Rs 3.5 trillion of reserve money over FY17.

Approach 2: A basic money demand model based on GDP growth does not capture RBI’s explicit intent to move the banking system from a deficit to a neutral regime.

If we assume reserve money growth for FY17 similar to last year's and take into account the incremental impact of removing the extant liquidity deficit, then the reserve money creation could be Rs 3.9 trillion (+18 percent).

This also takes into account the rise in bank deposits during the year.

Approach 3: Both the above-mentioned approaches do not take into account the recent concern for the banking sector liquidity – currency leakage with the public.

While there are theories talking about higher ATM withdrawals to save the hike in transaction tax, election related spending and hike in services tax among many others, we believe that if this becomes a structural problem, then RBI could be doing additional OMOs to encounter the problem.

In this regard, assuming that the recent surge in currency with public persists through the year, the reserve money creation could be around Rs 4.9 trillion in FY17 (+22 percent).

This is an extended framework of approach 2 mentioned above.

Thus, depending on the extent of foreign capital inflows, combining all the above-mentioned approaches, OMOs could be in the range of Rs 85 billion to 340 billion per month.

At the current pace, the RBI is largely relying on OMOs with an average infusion of Rs. 350 billion per month.This of course, is in addition to the cyclical demands met through the repo window and term-repos, on the basis of government’s cash balance with the RBI and other transitory factors.