RBI to Focus on Transmission: India Ratings

India Ratings' report on Monetary PolicyRBI Cuts Repo Rate: After taking a pause in its third bi-monthly review, the Reserve Bank of India (RBI) cut the repo rate by 50bp in its fourth bi-monthly review. As a result, repo rate, reverse repo rate and marginal standing facility rate now stand at 6.75%, 5.75% and 7.75%, respectively. This is in line with India Ratings and Research’s (Ind-Ra) expectation. RBI’s action is based on its belief that (i) despite Consumer Price Index inflation rising over the next few months due to the reversal of base effect, it will remain well within its comfort zone, (ii) despite the less-than-normal monsoon rainfall, risk from food inflation appears to be contained and (iii) tepid global demand, soft commodity prices coupled with postponement of policy normalisation by the US Fed have created additional head room. Therefore, instead of a 25bp cut it went for a 50bp rate cut.Rate Cuts Unlikely in 2HFY16: By calling 50bp repo rate cut a frontloaded policy action, in Ind-Ra’s view RBI has nearly shut the door on further rate cuts in FY16. Nevertheless, Ind-Ra believes that if conditions permit RBI's policy stance will continue to be accommodative. In the near term, however, the focus of RBI will be to work with the government to ensure that roadblocks to banks for the better transmission of the bulk of the cumulative 125bp cut in the policy rates are removed.FPI Limit Increased in Government Debt Securities: To make the investment regime more predictable for foreign portfolio investors (FPIs), the RBI has decided to increase their investment limits in phases to 5% of the outstanding stock by March 2018. In aggregate terms, this will create room for an additional investment of INR1,200bn for FPIs by March 2018. Ind-Ra believes this is a welcome step, will provide additional liquidity to the G-sec market and will have a softening impact on the yields.Monetary Transmission is Weak: Including toady’s action, RBI has made a reduction of 125bp in repo rate so far in 2015. However, the transmission of the rate cuts into the real economy has been relatively weak. A 75bp cut in repo rate, before today’s action, has resulted in the median base lending rates of banks falling by only about 30bp, despite extremely easy liquidity conditions. As the bank deposit rates have been reduced significantly in response to the reduction in policy rates, Ind-Ra opines that there is room for further transmission. However, the capital markets through commercial paper and corporate bonds have transmitted RBI’s policy actions to a large extent to the borrowers.Growth Momentum Visible but Feeble: According to RBI’s assessment, a tentative economic recovery is underway, but it is still far from robust. Under the evolving growth-inflation dynamics, Ind-Ra believes the policy stance reflects RBI’s continued intention to anchor both inflation and inflationary expectations while not being oblivious of growth concern. With the festival season round the corner, Ind-Ra opines that a 50bp repo rate cut can help revive consumption demand, particularly relating to durables and housing, provided banks pass on the benefit to the consumers.Corporate Sector to Benefit: Due to tepid demand conditions, the corporate sector over the past few years was finding it difficult to translate higher input cost into output prices. However, a fall in material cost due to benign commodity prices has translated into an increase in margins for most producers. Similarly, even the drop in cost of capital due to the reduction in repo rate has been benefiting the corporate sector. However, according to RBI’s assessment, weak aggregate demand has more than offset the effect of higher margins. As a result, corporates are still holding back new investment intentions. The expansion in capital goods production over the past 10 months, therefore, likely relates more to the revival of stalled projects than to a build-up of the greenfield pipeline.Comfortable Liquidity: Liquidity conditions remained comfortable during August to mid-September 2015. Also, the money market rates generally remained below the repo rate. The average net daily liquidity absorption by RBI in August was INR261bn and up to 15 September it was INR544bn. However, deficit conditions returned due to the quarterly tax outgo and RBI’s average net daily liquidity injections was of the order of INR544bn between 16 and 27 September.

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