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Last Updated : Jun 02, 2015 01:19 PM IST | Source: CNBC-TV18

'Rate cut inline but –ve RBI tone hints no room for more'

Experts believe the central bank will pause for a while now before one can see any rate cut in the near-future.

The Reserve Bank of India in its second bi-monthly policy on Tuesday, frontloaded its rate cut programme by slashing repo rates by 25 bps to 7.25 percent while keeping CRR and SLR rates unchanged at 4 percent and 21.5 percent, respectively.

Reacting to the news, experts said the rate cut was in line with the expectation but the RBI Governor raising inflation forecast is a worry. Experts believe the central bank will pause for a while now before one can see any rate cut in the near-future. 

The panel of experts includes Sajjid Chinoy of JPMorgan, Sonal Varma of Nomura Fin Advisory, Ananth Narayan, Head of Financial Markets, Standard Chartered Bank, Taimur Baig, Chief Economist-Asia at Deutsche Bank AG, Rashesh Shah, Chairman & CEO of Edelweiss Fin Svcs, Arundhati Bhattacharya, Chairman, State Bank of India, Ranjan Dhawan, MD & CEO, Bank of Baroda and Shilpa Kumar of ICICI Bank.

Below is verbatim transcript of the dicussion:

Q: What is your reading, one rate cut and that is it and inflation hike forecast for January 2016?

Chinoy: Exactly what we had thought. We had said we would get a dovish action but hawkish guidance. There are two-three ways to interpret this, the governor is saying he is frontloaded which means let us not hope for any more rate cuts in the near future.


The fact that we have 6 percent inflation forecast for next year is a clear massage that there is no more scope for easing unless one gets a significant growth disappointment over the next two quarters and assuming there is a normal monsoon on the back of that you get significant in sustained inflation prints, which are below the Reserve Bank of India’s (RBI) current forecast.

I think there are lots of ands in that statement that needs to be fulfilled if we have to consider the possibility of a rate cut. My reading would be we are at the end of this mini cycle and I think that was always what we believed.

Q: You think you will pass it on?

Dhawan: We did a base rate cut last month so quickly we would like to see in the next two or three weeks whether what the action is in the market and accordingly we will take action. I have to say that demand for credit remains weak so the passing on through will come in due course of time.

Q: What is your first reaction?

Narayan: This is as per the market expectation of a rate cut followed by the indications of a long pause. You might get a knee-jerk rally in bonds on the rate cut but markets will settle down where they are and maybe even weaken a little bit.

As per market expectations, don’t see yields either in the government bonds or in the corporate bonds going down significantly from where they were before the policy. So, it bakes the question, how much of rates can be transmitted by banks if there is no real change to interest rates through the policy.

Q: The RBI statement is completely silent on what they are going to do. So my reading of that is it is a long pause unless the governor chooses to say something more. There is no indication of anything that they will do further. All they say is we could have waited, we should have waited, we are front loading it, only hoping that that money will be used by the banks to push down rates and that will be used to ease supply constraints, what are your thoughts?

Varma: It is broadly in line with expectations. There was no point waiting until August if there was room then there was case for front loading and the silence on forward guidance essentially has to be seen in the context of the 75 bps rate cuts that has already been delivered in the first five months and it is time now for the RBI to wait and essentially see what impact this has in terms of transmission to the system lending rates to growth and then after on inflation.

There is no case for overreacting and broadly our assessment going forward is that a gradual growth recovery actually is likely to pan out and there are a few one off factors which are driving inflation down which we think will also start to even out.

The underlying inflation is also starting to stabilise around 5-5.5 percent plus the big challenge really for a central banker is inflation expectations down and I don’t think that battle has yet been won. So, for us it is actually a prolonged pause now actually to the extent that the RBI had a role to prevent growth sacrifice they have done their job. So, we are not looking for any more cuts from the RBI now.

Q: What is your sense in terms of future rate cut and how much of a risk does say the service tax rising to 14 percent hold in terms of their future trajectory?

Narayan: The text of the policy seems to indicate a long pause particularly if the RBI is pointedly increasing the inflation estimates for January 2016 that seems to indicate very clearly to the market that future rate cuts really aren’t coming through unless something dramatic happens to the commodity prices or food prices.


Q: From a market perspective it seems as though as it is quite a dismal reaction. Was the market expecting something more dovish in terms of future rate cuts?

Shah: Everybody was expecting a 25 basis point cut but hoping for 50 basis point cut and hawkish statement on top of that has got quite a few investors to worry that Reserve Bank of India (RBI) is seeing a return of inflation that we are not able to see.

RBI is seeing a lot more than what all of us are able to, so the caution and hawkishness of RBI it does indicate that may be we will go back to inflation inching higher up and grow slowing down and some form of stagflation coming back and that would be very harmful for corporate earnings.

Q: What is the likelihood of passing on the 25 basis points in terms of lending rate cuts and going forward how dismal do you think any sort of future trajectory of rate cuts would be?

Bhattacharya: Regarding the passing on of the rate cuts, you asked me this same question before the Governor gave his interview and you are asking it again and I have the same answer; I have to wait for the Asset-Liability Committee (ALCO) to meet and take a decision.

However, it is an easing cycle and therefore, there will be a tendency to pass on rate cut. How much we do it and when we do it is still something that the ALCO has to decide.

Q: What is your sense in terms of what came out from the RBI policy this time especially with the chances of future going forward?

Baig: The statement is very clear. RBI is done. It wants the banks to cut rates but I will second-guess the RBI. My argument would be while I hear the RBI loud and clear that they are done, they are worried about inflation but I think that they will be wrong on two counts, they would be wrong with respect to their worry about fuel price.

We think that global commodity prices, whatever rebound that we have seen it is over, it is going to flatten out from here onwards and they don’t have to worry too much about that pass through.

Secondly, the RBI has justified worries about the monsoon, below also would be proved to be wrong hopefully and primarily because we have seen in the last 10-15 years, the years when the government has been very good in managing the supply side with respect to food grains disbursement.

We haven’t seen a pick up in food inflation even when you had a bad monsoon. So I don’t know what the monsoon will be but I am fairly confident this government would be very proactive in heading off their food prices pressure.

On those two criteria, the things that is making the RBI right now fairly cautious will be reasons that the RBI will be able to relax two months from now so I would expect one more rate cut although I read from the statement they don’t want to cut anymore.

Q: You would expect it to the tune of 25 bps possibly post the August 4 policy which is the next time the RBI will meet?

Baig: That is right.

Q: The Governor spoke about the bank capitalisation where he mentioned that it maybe something which the government could support or the banks could tap into the markets as well. Do you think the government can do more in terms of capitalisation of banks in order to support them, the smaller ones which don’t fit the criteria which set out in terms of performance?

Bhattacharya: Yes but the Governor said that none of the banks need capital just as of now and that most of the banks will need this capital in order to fund the growth. Therefore, we are looking for growth capital.

I have a belief that as economy revs up there will be more confidence and therefore the banks will be in a position to raise money not only from the government but also from the markets.

Q: What is your sense in terms of passing on this 25 basis points or the likelihood of how much could be passed on because 75 basis points is what we have got in terms of total repo rate cuts but the system has only passed on around 25 basis points. How much more whenever that happens could we see in terms of lending rate cuts and by when?

Dhawan: One of the things that you have to see is that despite so much of Repo rate cuts the market has not reacted very much. The 10-Year yields are pretty much where they were in the morning despite a 25 basis point cut. Therefore, going forward, in the next two-three weeks we will have to see where the market finally settles.

We are definitely into an easing cycle, demand for credit remains weak. We will watch the markets for 2 or 3 weeks, going forward I do believe that there would be some rate cuts in store for us.

Q: We have barely seen a reaction on the yield but we have seen a stark reaction on the Bank Nifty, what is your sense in terms of the policy?

Narayan: I think the policy kind of instills some of the worst fears amongst market participants. If you notice, Rajan has essentially done two things, one is he has increased the inflation estimate to 6 percent and he has brought down the growth estimate. Now, the combination of that as Rashesh Shah was mentioning earlier is not good news at all for the market.

As far as bond markets are concerned, the other thing it implies, if the Reserve Bank of India (RBI) expects 6 percent inflation by January 2016 and given they have indicated a corridor of 1.5-2 percent for real interest rates, at 7.25 percent repo rate, the market is already on borrowed time and is getting a favour from the RBI at this particular level.

Both these aren’t good news which is why the market has completely the ignored the 25 basis points rate cut and is looking at the way forward. I guess the market is looking at a long pause for sometime to come.

Q: What have been your key takeaways? No more cuts. Do you buy this 6 percent inflation; do you think they will undershoot it?

Baig: We are not living in a world of high inflation risk. This is a general statement for the whole world; many parts of Asia all the way to China and beyond, the risks are inflation or deflation. India has its own domestic factors; monsoon, fuel prices, but in few months time we will be pleasantly surprise by developments on those areas.

On food side, this government’s proactive supply side measures will keep food prices another lid even if monsoons were to be poor and may not be poor. All that India Meteorological Department (IMD) has done so far is postpone the beginning of monsoon estimate by a week – that’s nothing in terms of margin of error.

I appreciate RBI’s caution but there is room for inflation to surprise us on the positive side and I also think that RBI will react to that development by cutting rates again but I agree that with this statement the RBI doesn’t want to cut any more given how worried it is. I am just second guessing that call right now.


Q: The Governor had steadfastly maintained that the positive real interest rates should be one and a half to two. By RBI’s own arithmetic now it is 1.25. So, what is your reaction to this?

Chinnoy: We should look at the real rate over a period of time and just picking one data point next year, yes you get 1.25 percent but remember the forecast for the following two years is four percent and the governor emphasized he wants to be on this disinflationary path where he goes from 6 percent to 4 percent.

Now, let’s assume you are somewhere in between and your average inflation is five percent over the next two years, then you still get a real rate of about 2.25 and maybe down the line there is a scope for one more ease.

We should not take it too literally and compare every inflation point, every policy point-this is a general rule of thumb that over the next two to three years, both to arrive at the disinflation of four percent and more importantly so that when the capex cycle picks up, any domestic investment is financed by domestic financial savings.

What you don’t want is reliance on external financial savings in two years time precisely when the Fed is in the midst of a rate hike cycle. To reinter mediate those savings you require real rates to be one and a half to two percent. So, that is the larger theme.

I will just make one point, it is clear here that the RBI thinks that they are done for now. They have been very flexible in the past, they will be data dependent.

If you get these massive downside surprises that Taimur speaks about, there is the likelihood of another cut on the line but the bar for any more easing has gone up dramatically for two reasons.

One is there is the monsoon risk but if you strip out the volatile components of inflation, take out fuel prices, take out vegetables, you get underlying inflations stabilizing at about five and a half percent. Now, think about this for a second.

Growth is extremely weak, rural economy is depressed, oil prices are at USD 65, the rupee has been very stable and you are still looking at an underlying inflation of five and a half. So, what the RBI’s calculus is that at some point growth picks up in the next four to six quarters and could increase pricing power which is why I think the bar for any more cuts is quite high.

Even if you undershoot the six percent number by a little bit, the RBI could always say from next year onwards our target is four percent within the upper end of the band and we don’t have space for easing. So, we have to get used to those ground realities.

Q: How have you read all this as a stock market investor? The last March rate cut was welcome with the peaking of the market. We never thought the Sensex go back to 30,000 or the Nifty go back to 9,000. What will the markets do today and here on?

Shah: The key verdict continues to be the increase in inflation estimates by RBI and the reduction of the growth estimates and that is truly very worrying for investors because all of us can see that the economy is slowing down and it needs some stimulus and people were hoping that we will get a combination of stimulus from the RBI and the government, a combination of fiscal stimulus by government spending and investment and RBI cutting rates.

Now all eyes will go back to the government spending plans and if there is a big kind of fiscal stimulus then hopefully corporate earnings will start going up. Otherwise for the next three-four quarters I would expect that analysts will keep on cutting down their estimates of earnings growth and all and which will have its impact on market and investor sentiment and all.

This is because we need to get some kind of shock treatment to get the growth going again because we have both investment cycle slowing down but the consumption cycle is also slowing down significantly and to get the investment and the consumption cycle to start in the next couple of quarters we needed both fiscal and monetary. Now that monetary is out of the way all of us will be watching the fiscal side of the equation.

Latha: Your take, how will bond yields behave? What is your reading of future RBI action over the remaining part of 2015 and hence the trajectory of bond yields?

Kumar: I would say the policy was on expected lines. Market was broadly expecting 25 basis cut which is what we got. On the other hand in terms of guidance while a lot of my colleagues in the market seem to think it was hawkish I think slightly differently.

In a sense he is saying, what most parts of the markets were thinking which is that is going to be a lot more data dependent here onwards. That essentially what he said so to my mind bond yields will look for data and will position themselves as and when we get further readings on inflation and growth.

Latha: How do you see CP/CD yields and even for that matter lending rates? There is a very clarion call that banks must pass on more, do you see that happening?

Kumar: If we look at how all the rates in the system will react, the wholesale markets do tend to respond far more quickly to changes in repo rate cut. Therefore to that extent the short-term liquid part of the market should see a downward direction earlier on.

As far as base rates are concerned, the important point is that the base rates are a combination of not just wholesale deposit rates but also retail rates across the spectrum of products and there indeed like many other people have said earlier, the small savings rate will play some factor in how far down those rates can go.

Last point I want to make is with the new liquidity guidelines that have come in. There is strong reason for banks to actually look for retail deposits more than wholesale deposits and to that extent I guess ALCO will naturally position rates in such a way as to attract a greater portion of retail deposits. So, with rate cuts while direction of all rates should follow, the extent and the timing will naturally differ.

Right now, pretty much base rates are between somewhere like 9.75 to 10 plus for most banks. As a combination of this whole liability profile and differential risk, we should see impact on all of these.

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First Published on Jun 2, 2015 11:35 am
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