RBI Monetary Policy: Bond yield may rise 15 bps; stance change may hurt, say experts

However, the stance does say that one should not expect rate cuts in the future but "it does enhance the credibility of the committee," says Narayan.

Jahangir Aziz, Asia Economic Research, JPMorgan believes that the change in languages tells us that the committee realises the supply side disruption due to demonetisation. "The language has now become more classic and [focused on] inflation targeting, which is good," he said.Narayan believes at the margin, the policy decision could be marginally positive for foreign institutional investor (FII) inflow. It is unlikey that the bond funds would exit because 10-year yield at around 6.75 percent could be attractive for them.He strongly believes that RBI is done with rate cuts unless there is a drastic change in the consumer price index trajectory.According to PK Gupta, MD, State Bank of India a rate cut would have helped the banks sustain their MCLR because the current rate cut sin lending rates were due to higher deposits in saving accounts and current account post demonetiation. However, now banks will have to look at their cost of funds because the credit offtake is very low. Although cut in deposit rates is likely, he adds.Pranjul Bhandari, Chief India Economist, HSBC is worried about the growth forecast of RBI wherein they expect a sharp recovery in FY18 because she feels consumption could recover but recovery in investment is still poor and unlikely to go up. However, the fact that RBI has been hawkish on one end and flexible on other is good, she says.Bankers are of the view that given the RBI policy stance too much drop in lending and deposit rates by them is not possible. KVS Manian, President – Corporate, Institutional & Investment Banking, Kotak Mahindra Bank Limited says the leeway to cut deposit rates now is not too high at least on the retail side but on wholesale side deposit rates may be cut.While, RK Bansal, ED, IDBI Bank feels it is unlikely that banks will cut rates in March but maybe look at cutting rates in April. Reduction in lending and deposit rates nowadays has become a dynamic situation and each bank takes its own decision, he says. With regards to cut in the savings rate, SBI will first have to take the lead and then other banks may follow, says Bansal.Transcripts on Page 2_PAGEBREAK_Below is the transcript of the experts' interview on CNBC-TV18Latha: The committee decided to change the stance from accommodative to neutral while keeping the policy rate on hold to assess how the transitory effects of demonetisation on inflation and output gap layout. It seems to indicate we are holding out because we are trying to assess. Does this mean there is some crack in the door and a cut can come?Aziz: I would say that the important point that I got from what you said about the language was that for the first time, you have a government related agency, and this is RBI, actually saying that look, the concerns that we always had about demonetisation, has it disrupted supply chains and the supply side of the economy. For the first time, indirectly, by linking demonetisation, the output gap and concerns that this output gap could actually narrow very quickly in the second half of the year because of supply side disruptions and therefore, create problems for inflation trajectory. And as a result, they are changing the policy stance from accommodative to neutral. Indirectly, for the first time, someone in the government is actually acknowledging that the supple side disruptions from demonetisation could be meaningful. That is material to me.In terms of your question, if inflation surprises you on the downside even further, it comes below 3 percent, let us say in April, then you would be forced to cut rates because you have a yawning gap between 3 and 4 percent at that point in time. But I would say that the message for me was that there is an indirect acknowledgement that demonetisation impact could be more than “just transient on demand”.Sonia: I wanted your thoughts on what you see as the inflation trajectory here on. I know we have discussed this, but from this policy, it is very obvious that the RBI sees inflation as very sticky, non-food and non-fuel especially. Would you change your inflation expectations going ahead and what are we looking at over the next 3-6 months?Aziz: I do not think we are going to change our inflation expectations going forward. Inflation expectations were already higher than RBI’s in the second half of this year. But I would go back to the point that Latha was raising. This is the third review from this particular Monetary Policy Committee (MPC) and you are seeing the language on the MPC changing towards more classical inflation targeting language. Just from what Latha had read out, they are now connecting the stance of monetary policy not to growth rates, not to inflation, but to output gaps and then to inflation.So, the important point is that they shifted from accommodative to neutral having concerns about what the output gap will play in the next few quarters or the time ahead. In general, when central banks, that our inflation is target is, do that they actually believe that the output gap is going to turn from negative, it will turn zero which essentially means that even with a higher growth, you are going to see the output gap being strained. That is the crucial thing for me to take away that the language is now becoming much more classical inflation targeting language and most likely we will see more of that. And rather than the kind of language that we had in the first two MPC, but sort of was a hybrid between the old system and the new system. So we need to get used to this new language and that is a big takeaway for me so far. Anuj: You were telling us that market was prepared for no rate cut but the language- dropping of the word accommodative? Narayan: This is a surprise. The market would have been okay if you had no rate cut but a mild dovish kind of policy that was the broad expectation. The change from accommodative stance to neutral was definitely not expected. With this the prospect of future rate cuts will be discounted by the market, which is no more rate cuts going forward. This is negative for bond markets. From the earlier estimate of 5 basis points sell-off, I would think you would at least see 15 basis points sell-off over the next few days. So, 6.45 percent going up to 6.60 percent on the 10-year bond cannot be ruled out. Latha: RBI does seem to say that we are only going to look at inflation – 4 percent and that is a very legitimate position. Does it look to you there is another cut? Narayan: If all this commentary had come in without a change of the stance from accommodative to neutral, I would have still said there is a door open ajar for maybe a rate cut in future if we see some surprises coming through. However now the threshold for surprise has gone up significantly. Clearly the MPC has taken a considered view that from accommodative this is a time to move to neutrality. I don’t think they are considering rate cuts in a hurry. In a sense this will enhance the credibility of the whole system. The fact that they are completely aligned towards targeting inflation will be seen positively. Having said that I still think there is a case for short end rates to come down given where credit offtake is particularly. The points that the RBI makes in the last paragraph are absolutely valid. We need changes in the way small savings rates are determined. We need recapitalisation of banks to come through. I would also add that maybe we can use the liquidity surplus that we have a little better. Overall given the state of the global markets, it is quite prudent to have rate cut not coming through. You can also justify moving the stance from accommodative to neutrality, I think it is prudent in that sense. It will give a lot of faith to the system as a whole. I would still argue though that there is room for short end rates to come down.Sonia: What is your view on what the policy entails now for the banking system and more importantly are we looking at any more lending rate cuts hereon? Gupta: As I said earlier, I think what has changed is the policy stance from accommodative to neutral. The current rate cuts that have happened in terms of lending rates or MCLR rates has been driven to a very large extent by the demonetisation, the money that has come into the banks, the current account saving account (CASA) deposits having gone up. So the moment those CASA deposits starts flowing out of the banks, I am not sure whether the banks will be able to keep their MCLRs at the current rate. So to sustain MCLR at this rate, we will have to cut the deposit rates. So a rate cut would have helped but otherwise also the banks will have to look at their cost of fund as of now the credit offtake is very low. So I think that adjustment in the deposit rates in any case will happen. As far as the enforcement thing is concerned, last year April policy itself, the RBI had announced that they are going to come up with the new enforcement framework so what they have announced is a follow-up on what they had announced in the April 16 policy. So this is something which was expected, it was supposed to come by June of last year so it is probably going to come in place now. Anuj: From hereon, going by the evidence of what we have from RBI, what will it do to your cost of funds going forward and the likely rate trajectory from hereon? Gupta: The cost of funds as of now is determined by the total funds the banks have been raising. So how long this demonetisation money, which has come into the banks, stays with the bank is going to be very important. How much of it stays in the savings bank and how much of it gets converted into the fixed deposits also. As I said, the banks will have to cut deposit rates. I don’t think there is any option on that because the offtake is not there. So obviously, the moment these savings deposits get converted into fixed deposits, on your fixed deposit rates, as of now also you are paying more than what you are earning by deploying the government in terms of repo rate. So even the government securities yield also is very low. So the deposited cuts will have to happen and your yield curve right now is absolutely flat. The short-term rates have to go down and in case the RBI stops taking money at the repo rate and they move it to the reverse repo, that itself will lead to a reduction in the short-term yield curve. The yield curve can become slightly upward sloping.Latha: Would there be an overestimation of growth in the current year – 6.9 percent? Bhandari: This number has got a lot of faults. Number one, it comes from CSO. CSO uses a lot of formal sector data in order to get a handle of how the informal sector is doing. If we were to believe that informal sector has got hurt more in demonetisation than the formal sector, it is quite likely that the slowdown will be underestimated by the CSO which means that the CSO might come out with very rosy prints on growth which may be much higher than what activity on the ground is looking like. I won’t really look at GDP data, what CSO represents that closely. I would really be looking at things like PMI indicators, car sales, things like investment growth, I think they are more at the heart of economic activity at this point. Latha: Are you sympathetic with this estimation itself – 6.9 percent? Are you in sync with it because I thought most of the numbers we got were lower than 6.9 percent and 7.4 percent next year? Are you okay or do you think these numbers will change? Bhandari: I am glad that they accepted that growth will be lower than 7.1 percent this year. In December they had said it will be 7.1 percent in FY17, I am glad they accept that it will be a little lower. I am okay about 6.9 percent. Actually it doesn’t really matter because the year is just ending in a months’ time. I am more concerned about FY18. I think they are expecting a sharp bounce back which may not really materialise as such. They are expecting a 7.4 percent growth, I think something closer to 7 percent is more likely because investment is likely to remain sluggish for the entire year. There is really no reason I see in the horizon, why investment should rise. Also one of the things we have seen is that consumption hasn’t fallen too much after demonetisation. A lot of people were expecting it to fall but for a variety of reasons including the fact that old notes were being used more than our policymakers had thought, that did not allow consumption to fall by too much. However the corollary of that is that growth and consumption will not rise back as sharply as well. Since it has not fallen so much in FY17, it won’t bounce back in FY18. So, I would have a little more muted expectations of growth, closer to the 7 percent range rather than closer to 7.5 percent range in FY18. That is one thing where RBI may have overestimated growth at this point. Q: What is your sense? Are saving deposit interest rate falling? Manian: Given the policy announcements today, too much drop in rates from here cannot be expected immediately. As the Governor said, RBI\\'s focus is also on transmission rather than further drop in rates. Q: The ball is in the court of the bankers, under current circumstances, I mean you cannot expect small savings cut immediately perhaps, you cannot expect the NPLs and the recapitalisation issues immediately - under current circumstances, how much more can money get cheaper? Manian: It depends on what you take as reference point in time but if you take it from the peak, the policy rates are down about 175 bps, for example our own base rate and marginal cost of lending rate (MCLR) combination during this period is 120-130 bps below its peak. So there is significant amount of transmission on the lending side has happened. The deposit rates do not keep pace with the policy rates on the downwards side. Therefore, it is unlikely that the entire 175 on paise-to-paise basis is likely to be passed. However, it could vary bank-to-bank but many banks are very close to almost full transmission maybe a small leeway available to them from here. Latha: What is your sense, RBIs indication seems to be no more rate cuts from them. Would that be true of the banks as well, no more lending rate cuts, will there be any deposit rate cuts? Bansal: I have been always maintaining that repo rate is not a very big function where banks take their call to reduce or increase the interest rates. Banks, if you really see the last one month, in January also most of the banks have reduced their MCLR substantially, in fact without RBI taking any repo rate action at that point of time. Even some banks have reduced even from February 1. So, whichever bank there is monthly, I think they are reducing. IDBI also we reduced from February 1 though we normally do quarterly. However, because this time cost was going down so steeply, so the one thing which we have to see is that this CASA deposits are quite substantial and bulk deposits rates are also going down substantially because lending is not happening much. So, banks are flushed with funds so they will be forced to reduce the interest rates which is happening already. Latha: You expect further cuts in both deposits and lending rates, approximately when, will it take a month, will it be immediate? Bansal: I feel nowadays it has become a very dynamic type situation. Each bank is taking a review almost every month. However, I still feel because March being a financial year ending, banks may not take that view now up to March but certainly I think in April or so perhaps they will be forced to do that.