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Not just about interest rates, Urjit's RBI policy had plenty of action

In a nutshell, the RBI is hawkish on inflation, bullish on growth, proactive on liquidity management and serious about non-performing assets (NPA) resolution.

April 06, 2017 / 05:04 PM IST
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The headline of ‘no rate action’ in the Reserve Bank of India (RBI) policy does a disservice to the measured but very definite activity underway at India’s central bank. To put it in a nutshell, the RBI is hawkish on inflation, bullish on growth, proactive on liquidity management and serious about non-performing assets (NPA) resolution.

The central bank didn't prove the economists wrong with its rate (in) action. But as we have highlighted before, the operative rate is contingent on the liquidity in the system. For instance, in a tight liquidity scenario, the repo rate or the rate at which the RBI lends money to the banks is the signalling rate, while when there is plenty of money in the system, and banks lend money to the RBI, the reverse repo rate becomes the signalling rate. In an environment of abundant liquidity, it has narrowed the policy rate corridor to 25 basis points from the earlier 50 bps by hiking the reverse repo rate from 5.75 percent to 6 percent. Consequently, the Marginal Standing Facility (MSF) and Bank Rate have been revised down by 25 basis points to 6.5 percent, 25 basis points above the repo rate.

RBI stuck to its objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent. However, it flagged multiple risks to inflation. First and foremost is the uncertainty surrounding the outcome of the south-west monsoon in view of the rising probability of an El Niño event and its implications for food inflation. Others include implementation of the allowances recommended by the 7th Pay Commission. Another upside risk flagged by the RBI arises from the one-off effects of the GST (goods and service tax). The bank sounded cautious about the recent spate of farm loan waivers and the risk that the same poses for the exchequer and hence inflation.

On the external front, while acknowledging the salutary impact of softer crude, the bank remains watchful about the revival of growth in the developed economies that might support a commodity rally and could have a pass-through into domestic inflation

While hawkish on its inflation outlook, the RBI is extremely optimistic about growth revival in FY18. It projects strengthening of GVA (Gross Value added) growth to 7.4 percent in 2017-18 from 6.7 percent in 2016-17.

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The optimism stems from the pace of remonetisation that should propel discretionary consumer spending; the transmission of past policy rate reductions into banks’ lending rates post demonetisation that should encourage both consumption and investment demand of corporates; the thrust on Capital and Social sector spending in the Union Budget that should invigorate economic activity; reform moves like GST, the institution of the Insolvency and Bankruptcy Code, and the abolition of the Foreign Investment Promotion Board that should boost investor confidence and bring efficiency gains; and finally the upsurge in initial public offerings in the primary capital market augurs well for investment and growth.

The RBI expects the effect of demonetisation to wane over time and perhaps fade away by Q4 FY17. At the outset of FY18, the bullish outlook on growth and caution on inflation does point to a “no rate action” for longer. To soothe the sentiment of bankers, the subsequent announcements were music to their ears.

While expressing confidence about progressive remonetisation aiding the system to move back to the “neutral liquidity” zone, the RBI, without delving into the specifics, hinted at deploying its entire toolkit in an endeavour to mop up the surplus liquidity without impacting short-term rates. The 25 basis points hike in the reverse repo rate coupled with RBI’s endeavour to mop up liquidity without impacting the short-term rates will be marginally earnings positive for banks.

The RBI hinted at continuing variable reverse repo auctions with a preference for longer term tenors, continuing with the Market Stabilisation Scheme (MSS), using open market operations (OMO sales and purchases) to move to neutral liquidity and issuing cash management bills (CMBs) of appropriate tenors in accordance with the memorandum of understanding with the Government of India.

While falling short of announcing the much expected Standing Deposit Facility (SDF), the policy did mention that the instrument is under active consideration – again, this should soothe the nerves of bankers who were fearing a CRR hike.

The other announcement that caught our attention was the banks seriousness in getting the NPA problem out of the way. The policy made a reference to reintroduction of Revised Prompt Corrective Action (PCA) framework for banks that will set out guidelines on several parameters that will be monitored closely including – capital position, quality of assets, return ratios etc. In view of the enhanced role of ARCs (asset reconstruction companies) and greater cash-based transactions, RBI has hiked the minimum net worth to Rs 100 crore for ARCs.

As a considerate regulator, RBI has allowed banks to substitute collateral under the LAF Term Repos and permitted them to invest in REITS and InvITs in addition to the current permissible instruments like equity-linked mutual funds, venture capital funds (VCFs) and equities to the extent of 20 percent of their Net Owned Funds. This should be music to the ears of companies like DLF, IRB and many other companies from the beleaguered infrastructure and real estate sector who may be mulling such structures.

So there are plenty of sweeteners to counter the mild bitter aftertaste left by the RBI’s slightly hawkish stance.

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