'RBI to take dovish stance; need for liquidity in H2FY13'

Ahead of the Reserve Bank of India's monetary policy review on Tuesday, Indranil Sengupta of Bank of America Merrill Lynch expects to see a dovish stance from the RBI. He is hopeful of a 50bps cash reserve ratio or CRR cut from the central bank tomorrow. But, he feels a 25bps repo rate cut may come only in December.

Moreover, Sengupta believes inflation will be at 7.5 to 8% levels and it is a positive sign to see food inflation toning down across the board. He is also in favour of liquidity easing which he thinks will help to reduce lending rates. Also read: Unlikely to see rate cut from RBI tomorrow, says UBS
Vivek Rajpal of Nomura India however, is not very hopeful of a rate cut tomorrow. He feels a rate cut would lead to a bonds rally from current levels. But, there is also a huge requirement for liquidity infusion, around Rs 80,000 to Rs 90,000 crore in the second half of FY13, added Rajpal. Here is the edited transcript of the interview on CNBC-TV18. Q: We understand the Finance Minister is announcing something by way of a fiscal consolidation plan just 24 hours before the credit policy. What impact do you think it will have on the policy tomorrow? What are you expecting the governor to say? Sengupta: Clearly, the RBI easing this time will be higher than the RBI easing last time given the fact that the government has taken a number of measures, given the fact that rainfall has clearly revived. We are actually expecting a 50 bps CRR cut this time versus 25 bps last time. We expect a rate cut from December onwards, 75 bps. However, one has to wait and watch what the FM actually says. Q: Can you just give us a rationale on why you are expecting a 50 bps CRR cut? Sengupta: Deposit growth is just 14 percent and loan demand is clearly higher. Lending rates today are at their 2008 peak. India is the only country in the world where lending rates are at their 2008 peak. Effectively, we have lending rates of a 9 percent growth economy at a 5.5 percent growth economy. My view is that unless lending rates come down, India will struggle to get to 5.6 percent growth, forget 6.5 percent growth that the RBI is projecting. That is why I think all efforts should be made at this point to bring down lending rates, to push up deposit growth. Q: We are also an outliner on inflation at 8 percent at a WPI level, at 10 percent at a CPI level and by our own standards we used to rank 75th in a tally of 150 countries. Now we are ranking almost closer to a 150 in terms of inflation control. Apart from all that data, since the RBI's stance has been to concentrate on that, will they be able to cut rates the way you are saying, CRR included and move to perhaps 2-3 readings of 8 percent? Sengupta: The first thing is that if you see inflation adjusted for growth, India is just like anybody else. It is not correct to see the absolute level of inflation. For example, inflation in India maybe close to 8 percent, but growth is 6 percent. In Brazil inflation is 6 percent, lower than India, but growth is 0.5 percent.
The level of stagflation I would say in India is probably much less than in most other countries. Moreover, given the fact that inflation will be around 7.5-8 percent till December, I do think that the RBI would prefer to cut rates from December.
_PAGEBREAK_ Q: What exactly are the bonds factoring in or the 10 year at around 8.13 percent for tomorrow? Rajpal: I don't think bonds are fully pricing in 25 basis point of rate cut, though we do not expect a rate cut. In case there is any rate cut, bonds will see a rally from the current levels. As far as market pricing in is concerned, I don't think balance sheet products that is sovereign bonds, are pricing in rates. Q: Are they pricing in a CRR Cut then? Rajpal: CRR cut pricing by bonds is a little difficult to explain Q: If CRR cut comes, how will bonds behave? If a rate cut comes, how will bonds behave? Rajpal: I do not think much will happen in bonds if a CRR cut comes because ultimately there is so much of liquidity infusion requirement that in the second half of the fiscal year that bonds will stay supported on the expectation of open market operations (OMOs), We expect around Rs 80,000 to 90,000 crore of OMOs in the second half of the fiscal year. However, if a repo rate cut comes then bonds will rally. Q: To dwell on it further, because we did get a 25 basis CRR cut in September 17, give us a sense in terms of the liquidity scenario post the CRR cut in September and what does it currently stand at? What is your estimate during the festive season, how difficult do you think it could get? Rajpal: There are two dredges to the liquidity from the banking system at a broader level. One is currency in circulation. The currency in circulation would require around Rs 80,000 to 90,000 crore of liquidity injection in the second half of the year. Secondly, there are these onshore forwards which will expire over the next 6 months or so. We don’t have the exact maturity profile but, according to the latest monthly bulletin from the RBI, they are around Rs 1450 crore outstanding and they are also expiring.
The bigger point is there is a huge need of liquidity infusion in the second half of the fiscal year. The CRR cut tomorrow can only change the timing aspect of OMOs, they cannot change the total requirement of liquidity infusion overall. Q: What else are you expecting from the Reserve Bank? Other than the 50 bps CRR cut, do you expect any of those micro prudential steps to be touched, because it is one of those big half yearly policies and how will the stance sound? Sengupta: I think the stance will be dovish. Given where growth is, we are also expecting the Reserve Bank to cut their growth forecasts from 6.5-6 percent. We are at 5.6 percent and because this is also the banking policy we are looking at three possible things.
Number one, there could be some prudential tightening on loans to sensitive sectors like real estate, housing or restructured loans. That is something we have been calling for continuously. Number two, we could see some implementation of the Usha Thorat Committee Report wherein you have the gradual putting in of a level playing field between banks and NBFCs. Finally, there is an anomaly in the sense that SLR is now 23 percent, the Hold-To-Maturity (HTM) is 25 percent of book and there might be some rationalization there.
_PAGEBREAK_ Q: Just wanted to touch upon the inflation trajectory that you expect. The previous reading was at a 10-month high and we had that 30 bps factored in because of the diesel price hike we saw before that. But give us a sense in terms of how exactly the trajectory would possibly progress in the next couple of months and what would be a level which would be possibly comfortable with the RBI? Sengupta: I think inflation will peak at 7.5-8 percent levels. The incoming data on agflation is actually quite encouraging because the food price inflation seems to be toning down across the board and it is a very positive sign. I think by December we would have clarity about inflation peaking off and that would provide RBI the comfort to cut rates. Q: Do you think that they would possibly hold their fire in terms of a lot of aggression tomorrow? Wait and see how inflation pans out and then possibly take a call post December? Sengupta: I think the RBI does not have the luxury of holding their fire given where growth is. There has to be easing. Whether you send the signal through rates or not, I do not know. We do not expect a rate cut, but certainly more liquidity easing to pull down lending rates. Q: When does this Rs 1 lakh crore or maybe Rs 90,000 crore deficit ease off on its own? This is a seasonal phenomenon when a lot of currency increases with the public around Diwali. How does it ease and therefore do you think how much of OMO help will and should come? Rajpal: Basically, there are two aspects of looking at the liquidity, one is the banking system liquidity and the other is the banking system liquidity plus government balances. For example, the current high LAF numbers are a result of high government balances. Typically, government builds up balances from October to December then spends the money and again builds the bank balances from January to March.
Our sense is that RBI will look at the total system liquidity deficit when it comes out with Open Market Operations (OMOs). The expenditure patterns of government are sometimes very weird and RBI would like to take that into account. Our sense is by mid-November or third week of November we will see total system liquidity which is government balances plus the banking system liquidity deficit to be greater than 1 percent of Net Demand and Time Liabilities (NDTL). That is when we expect RBI to come up with OMOs. Q: There is a source based information that there are plans to bring down the fiscal deficit to 3 percent over the next five years or possibly the five year plan. Give us a sense of what you are expecting from the Finance Minister in terms of a fiscal consolidation plan? Sengupta: We are expecting a fiscal deficit of 5.7 percent of GDP this year. I think the future will depend on where the growth cycle goes. If we see revival of the growth cycle, the fiscal deficit will clearly come down to 3 percent. But, right now we are at the bottom of the growth cycle and too much of fiscal consolidation will actually hurt the economy rather than help. Q: If the Finance Minister begins this timetable with a 5.3 percent for the current year, will the markets believe it? Rajpal: From our economic scheme point of view, 5.3 percent is optimistic. However, from market’s perspective I would like to point out that what matters to the bond markets is the supply in the second half of the year.