Radhika Rao
We expect the Reserve Bank of India to cut rates by 50 basis points over the rest of this financial year; of this, the first 25 bps cut is likely this week. Sub-target inflation provides the monetary policy committee room to focus on growth, factoring in incoming weak numbers (auto, cement sales, production, etc.) and the limited role of fiscal policy in supporting growth. The RBI has been ahead of the curve in delivering three rate cuts totalling 75 bps in February-June, and has likened its shift to an accommodative stance to a 25bp cut. Following the Governor’s comments last month, if it believes enough has been done, the RBI could focus on improving monetary policy transmission, instead.
Besides monetary policy, there are other things weighing on the central bank’s mind. The foremost is to ensure that policy easing matters to borrowing costs. Banks’ six-months to one-year lending rates are lower by an average of 5-15 bps since the start of 2019, a fraction of repo rate cuts. The country’s largest bank recently announced cuts in time deposit rates, which is expected to help lower loan rates down the line. Sharper cuts are, however, a challenge as cutting deposit rates further will require returns on national small saving to also fall meaningfully.
Plans to link lending rates to external benchmarks, in a bid to expedite the transmission process, was deferred at the April rate review. Another important piece in this puzzle is the liquidity stance, towards which an official framework was expected to be tabled last month and stands delayed. A shift from neutral to surplus will turn the situation conducive for transmission. Until then, the mechanism largely relies on the respective banks’ balance sheet strength, deposits size, and anticipated duration of the rate-cutting cycle. Transmission has been better in the bond markets though that arguably is less beneficial to stakeholders vs banks’ lending rates.
It is equally important for RBI to ensure financial stability and address troubles facing non-bank finance companies (NBFCs), which is a priority on two counts – the need to contain contagion risks and limit the fallout on growth. The sector has faced headwinds for the past nearly one year, with the recent Budget incentivising banks to buy highly-rated NBFC assets, along with bringing housing bank finance companies under the RBI’s jurisdiction to tighten the regulatory outreach.
An outright rescue package does not appear to be under consideration, but piecemeal support is underway to strengthen, stabilise and reduce the sector’s regulatory arbitrage. Most recently, the National Housing Board announced a liquidity support package of Rs 10,000 crore for housing finance companies (HFCs), to improve flow of funds for housing loans. We expect liquidity support to be accompanied by stricter vigilance (correcting asset-liability mismatches). Barring a full-fledged asset quality review of the sector, spurts of balance sheet stress amongst the players will hog the headlines, as borrowing costs remain elevated and funding availability tightens.
Finance Minister Sitharaman attempted to resolve the confusion over the maiden offshore bond issuance, after resistance from ex-central bank officials and labor unions/ideological backers of the government. Discussions suggest that the issuance might be in tranches, while the shape and structure is still undecided. Our sense is that the debut issue might be to the tune of $3-4 billion, launched concurrently at major international hubs including London, Singapore, Hong Kong etc. and is likely to be preceded by roadshows. Global demand for Indian papers will be strong in this environment where negative yielding debt has expanded to $13-14 trillion and yield hungry investors watch for EM/ Asian region which are less affected by the trade conflicts.
With an offshore bond issuance, the government intends to tap a new investor base, lighten domestic issuance, and take advantage of India’s relatively lower government external debt to GDP ratio. But there are pitfalls, by way of exchange rate risk is borne by the government, smaller net savings on cost on hedged basis, another avenue for external volatility to permeate through to domestic markets and increase in external debt (foreign reserves are 70 percent of total external debt). As and when issuance plans firm up, the RBI as the government’s debt manager will be required to comb through the nuances; the RBI Board plans to meet on Aug 16 to discuss the proposed issue.
Finally, the challenging global environment also requires policymakers to stay vigilant. To shield against the fallout of the prolonged US-China trade conflict and slowing global growth, G3 central bankers signal a return to the era of asset purchases. This suggests liquidity conditions will be flush, carrying its own risks of mispricing risks and volatile portfolio flows. If markets perceive additional policy measures as insufficient to reverse the growth downturn, risk-appetite is likely to take a beating, keeping the emerging markets bloc on tenterhooks. The RBI would be keen to safeguard against any impact on the rupee and domestic markets. Short-term and sovereign external debt levels are manageable, yet FX reserves accumulation is bound to remain a priority to ensure better coverage of total external debt levels. The true test of might will be in midst of a strong US dollar or a worsening global outlook in additional to heightened global volatility.
Radhika Rao is a senior vice president at DBS Bank, Singapore. Views are personal.
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