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Jun 07, 2017 07:11 PM IST | Source: CNBC-TV18

Is there scope for a rate cut? Experts think RBI could move in August policy

If the monsoon is progressing well, we think August would be the right time for a rate cut before inflation begins to turn up later in the year, said JP Morgan's Sajjid Chinoy.

Although it is no secret that the government and India Inc want a rate cut, the monetary policy committee (MPC) did not oblige.

The MPC today decided to keep the repo rate unchanged at 6.25 percent, while cutting SLR by 50 basis points to 20 percent. The forecast on inflation was also lowered, given the lower inflation numbers for April.

Market participants perceived the policy to be more dovish than the previous one, thereby increasing the probability of a rate cut in the August policy review. Both bonds and the rupee appreciated after the announcement, with the 10-year benchmark bond yield trading down at 6.57 percent and the rupee appreciating 9 paise to 64.34 to the dollar.

However, for those expecting a cut, there is still some hope because the RBI has softened its stance on inflation hinting that it could be "more accommodative" in the coming days.

Meanwhile, the RBI Governor also revealed that the MPC rejected an invitation from finance ministry for a meeting ahead of the policy.

To discuss whether there is a scope for rate cut and other aspects of the policy, CNBC-TV18 spoke to top bankers and economists - Umesh Revankar, MD, Shriram Transport Finance, Sajjid Chinoy, Asia Economics, JP Morgan, Ananth Narayan, Head- Financial Markets, Standard Chartered Bank and Dinesh Kumar Khara, MD & Group Executive, SBI.

Below is the transcript of the discussion.

Q: What did you make? Would you say they will cut if it came within 2-2.5 percent, will they wait for it to be even lower than the revised estimate?

Chinoy: Let us step back a little bit. The first thing to note is that the Monetary Policy Committee (MPC) has acknowledged that growth inflation dynamics in this economy are materially different from what they were 2-3 months ago. To mark down your inflation forecast by 175 basis points, 100 basis points suggests that they are thinking about the inflation out-turn quite differently now.

In an inflation targeting framework, you do not worry so much about two months, three months, four months. The MPC needs to be convinced that whatever their forecasts are in the coming year that they are not materially above the 4 percent mark because the statement again reiterated that their medium-term commitment is to keep it close to 4 percent and they added keeping in mind the output gap.

So as long as there is a belief here that my 12-month forecast is close to 4 percent and they believe the output gap is still negative, if core inflation is still falling, some space for easing will open up.

One more thing I will say, remember the real rate that the MPC was working with in April, when their one-year forecast was 5 percent, now will be much higher if their one-year forecast turns out to be even at the upper end of their band which is 4.5 percent. So that tells me, if you read between the lines that if in fact, there is a big if, the data turns out this way, the disinflation is not transient, it is more structural specially on food, that space for modest easing is possible later in the year, 25-50 basis points.

Q: What do you take away as a bond expert from the policy?

Narayan: We were not really expecting. I do not think anybody in the market was expecting a rate cut in this particular policy. Given the previous three MPC meetings came out with pretty hawkish outcomes, it would have been stunning for them to actually do a rate cut here. But short of doing that, I guess they have prepared the ground for a rate cut as early as August.

The sharp revisions down that we have seen in inflation, where even if you take the upper end of the ranges that the RBI has taken, we are still within the 4 percent average mark for the full year. The real rates at a 6 percent policy rate would still be pretty high compared to any of the norms that we have seen so far being thrown around on what real rates ought to be. So clearly the room for a 25-50 basis point rate cut have been opened up in the second half of the year.

Unless the trajectory of inflation changes dramatically from here and by the way, there are imponderables as the Governor rightly pointed out that we still do not know about, I would expect that the rate cut could come through. It still leaves an open questions on whether the rate cut is warranted and what is the impact on various market factors, etc. but nevertheless, this is as close as the RBI could have come to actually doing a rate cut, preparing the ground for a rate cut and then coming up with pretty dovish talk.

Q: Do you read this RBI statement and Viral Acharya's response to my question as pencilling in a rate cut?

Khara: As I read the Governor's statements and what Deputy Governor has also mentioned, based upon that, they are acknowledging that there is a downward movement as far as the prices are concerned, as far as the inflation is concerned, but they probably want to wait and watch because one, of course, the monsoon, though of course, it has been predicted that in terms of long-term average it would be as strong as 98-99 percent. But probably they would like to wait and watch till how the situation emerges post monsoon, that is one.

The second possible reason could be the goods and services (GST) also, it is otherwise expected that it will not be inflationary, but they will like to wait and watch how really it pans out and what impact it brings on the inflation though the rates which have been announced did not sound to be inflationary at all. So they are acknowledging the fact.

Q: CEA is not giving the benefit of doubt at all. CEA is actually saying inflation forecast errors by RBI have been large, inflation outlook has been rendered benign by a good monsoon and by an appreciating currency and of course growth has decelerated. RBIs talk about private consumption being high is not borne out because even retail loans are falling. So, he has taken piece by piece the arguments. Does this put additional pressure and therefore your reaction to the reaction?

Chinoy: With the latest RBI inflation forecast coming down so much I think the gulf is quite narrow now. So, all of us now believe that inflation is going to be based on the information we have now in that 3.5-4.5 percent range which would be relatively benign given the history of inflation which would remain close to the 4 percent target that the RBI has. That is why we think a little space of easing has opened up.

I think the other part here, the other new information is what we learned from the CSO last week. I think the fact that there is now more confirmation that he GDP data is saying what the other high frequency data has been saying for a while that this is an economy that was slowing even before demonetisation and demonetisation has intensified that.

I guess with the MPC what comes out is, they just want to be convinced that this process is not transient and that this is more secular. So, that is the source I think of the difference in interpretation.

Q: When do you all expect the cut? First if you expect and when?

Chinoy: Our base line case is still for August. We still think June and July are going to be in the 2 percent handle. If the monsoon is progressing well, we think August would be the right time before inflation begins to turn up later in the year.

Q: Do you expect a cut and when?

Narayan: August and I tend to agree with Sajjid.

Q: Do you expect the cost of money to have fallen for you? Today bond prices are 50 paise higher and yields are about 10 basis points lower.

Revankar: It has not really moved in the last 2-3 months. In fact I was expecting some rate cut this time, even the market was not expecting. I did say in the past that 25-50 basis points scope is there for rate cut in this calendar year. So, rate cut would indicate and probably the borrowing cost can come down a bit. I do expect rate cut in August. Maybe the food inflation is the only fear or suspense that people have. Once good monsoon is there then I think rate cut should be there.

I do expect total 50 basis points in this calendar year and that should bring down our borrowing costs substantially.

Q: How would you react as the bond expert? Today it was only 10 basis points but with each passing inflation number coming in below 3 percent and moving towards 2 percent, which is what all economists are expecting, do you see bond yields going towards 6.3 percent?

Narayan: The momentum is pretty strong and the next couple of prints in inflation will be pretty low. In fact some economists are even predicting a number sub 2 percent. So, the next couple of prints can be really soft. To that extent the bond rally will continue particularly in the short end of the curve, upto the 5 year segment we will see the segment continue. The longer end will be little more tougher. I must hasten to add that this is not all hunky and dory. While the market has been calling for lower rates and for rate cuts and for short end rates to come down, I think it is also good to take a step back and recognise that there are long term risks that we need to be worried about. State government finances aren't looking great and all this talk of farm loan waivers spreading is not a good sign. Personally I have a bit of concern around what is happening in equity markets. I am not an equity expert but the amount of retail money which is going in there as a regular inflow at PE levels of 23i don't think is a great sign particularly when the underlying fundamentals and earnings are not looking that great. Likewise what is happening on the rupee side with overvaluation and with money coming in, it doesn't make great reading for financial stability perspective.

So, while I think short end rates, there is a strong case for it to come down given the nature of the banking health, given what is happening on credit offtake and rupee etc, longer term I would be cautious about calling for a big rally on the longer end of the curve. I think the longer term implications and the fundamentals are very different.

Q: How much do you think home loans can get cheaper? You have got lower capital and lower provisioning.

Khara: As you are aware that home loans are majorly linked to marginal cost of funds based lending rate (MCLR). So MCLR is essentially equation based which has got a lot of bearing on the cost of funds. We have already come down significantly and the market has really heated in terms of practically all the important players have reduced their home loan rates significantly in the last 2-3 months time. So, much of it will depend upon how the cost of funds really evolve going forward. So as of now, we may not be in a position to articulate how much would be the reduction.

Q: I also wanted your key takeaways on how RBI will resolve non-performing assets (NPA). What will make of Deputy Governor, Vishwanathan's statement? I got a sense that they are going to be perhaps a little actively involved in restructuring loans themselves?

Khara: The intent is never like that but the intent is to guide the banking system for the resolution. So Mr Vishwanathan's statement relating to it was a reinforcement of the RBI's earlier statement that we would like to resolve the top-few accounts at the earliest. And I think it is in terms of the effort in terms of the Oversight Committees (OC) being set up. I would say that it is a work in progress and they have announced it in this policy statement which also reinforces their commitment for the resolution of the stressed assets in the banking system.

Q: How did you interpret the statement on NPA resolution?

Narayan: Actually Mr Khara is the bigger expert on this and I will defer to his views and I tend to agree with him. I think it is a broader topic clearly outside of the domain of monetary policy as well. I still think we need a much broader Ministry of Finance, RBI, industry, a bigger approach to solve the NPA issue. Beyond my paygrade, but I do think the efforts here still require a fillip from what we have currently and we probably need bigger solutions than what is going on right now.

Q: What is your sense, in the next six months, what may the ten-year be?

Chinoy: Really depends on if inflation does turn out in the 2 percent handle in the next couple of months, markets will begin to expect that there are probably 25-50 basis points of easing left in this cycle. Not more than that, I think that is the limit here. I think the ten-year will gradually begin to reflect that. You saw a little bit of that today and as you will see it progressively as these prints pan out and the expectation grows that there will be some easing to come.

Q: Your best guess of where the ten-year will be, say September 30?

Narayan: The bigger movement will probably likely happen in the shorter end of the curve. So the three-year, five-year bonds which have rallied by 10 basis points today, that could come down to 6.5 percent from the 6.72 odd percent they are currently. 10-year bonds I would be a little more cautious.

While they ended today in a decent rally, 6.55 or so, 6.40 was probably where they would land up. As Sajjid was saying, I think the rate cuts the market will pencil in will be 25-50 basis points at best and given there are lots of other issues which will impact the bond curve including what happens in the state government's side, etc. the longer end of the curve will be a lot more cautious.

Q: What did you make of the pressure that came from the CEA? Your reaction to the CEA's statement?

Narayan: If the previous question was beyond my paygrade, this is beyond my I-don't-know what grade. Just to be slightly more balanced on this, clearly it is factual that the inflation estimates have been over the last 3-4 years, higher than what the end inflation eventually ended up to be, but to be fair to the RBI, that is true probably for most forecasters, not just the RBI.

Where the market was genuinely surprised from the inflation forecast was the last 4-5 months, when towards the November policy where we still talking about the 5 percent March inflation which did not really synchronise with what the market was expecting. The last six months was where we had a bit of a concern and probably unfairly, because that was the start of the MPC process, we kind of imputed that to mean that the MPC, with and inflation target would naturally be biased towards pushing inflation higher. It is a surmise, it is speculation.

I give a lot of credit to the RBI for correcting the number today the way they have. It is a very big correction. Hopefully they will come out with a model which is a lot more better at estimating inflation going forward. But it is a horribly impossible task, given the amount of imponderables here, given 46 percent is food, it is very difficult to estimate inflation in a meaningful way.
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