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RBI monetary policy meet: Central bank on hold for now, but leaves room for future rate action

Madan Sabnavis
The next few days will be very crucial for the central bank and markets and the earlier a decision taken on Urjit Patel's resignation, the better it will be to eschew speculation

The fifth bi-monthly policy for FY19 has turned out to be quite uneventful as there were expectations of surprises in the form of a change in stance or a Cash Reserve Ratio (CRR) cut, which did not materialise.

The credit policy is normally all about four issues. First is interest rate. No change was expected in the repo rate given that there are still uncertainties regarding the future movement of oil prices given the temporary lull witnessed in the last month. There has been no change in the repo rate this time.

Second, there is a call to be taken on liquidity measures like CRR. A cut was possible given the liquidity situation in the market as well as the language used by the government on the subject. A CRR cut of 50 bps would have released at least Rs 65,000 crore. The RBI is either satisfied that there is no need to inject such a quantum of funds into the system or that it would use open market operations (OMOs) to provide comfort as and when it is required.

Interestingly, there has been no talk on the liquidity subject which was also not on the outcome agenda of the RBI board meeting held last month. It may be assumed that the situation is well under control and does not call for any additional intervention beyond what has been done by the RBI.

The third phrase that one looks for is the stance, which has become fashionable these days. Terms like hawkish or dovish are used by the media while the official language moves between being neutral, accommodative and more recently 'calibrated tightening'. The stance of calibrated tightening has been taken by the RBI which is interesting. This is so because it has lowered its inflation forecast to 2.7-3.2% for H2 based on its assessment of the inflationary forces in economy. In such a case, a change of stance to neutral would have been expected. Clearly, the RBI would be watchful and see how the inflation numbers behave the next two months before it changes the stance, which can be a precursor to a rate cut if so dictated by the inflation number.

Fourth, the macro forecasts especially on the GDP are interesting. Here, the stance has not changed and 7.4% is retained. This is positive for the market because with the Q2 number coming in low at 7.1% and the liquidity situation being under pressure given the non-banking finance company (NBFC) problem, there was a possibility of the forecast being lowered. The RBI has not changed the stance which also means that the liquidity issue that has dominated headlines for two months now is not a concern as the central bank has not only addressed it adequately but also feels the damage to the economy, if any, is not significant.

How will the markets react? This should be positive for the market and the government securities yields should come down which is good for the banks in so far as their market-to-market (MTM) losses will come down and turn profitable. Government borrowing also would benefit at a lower cost. In terms of deposit holders, there may be no change as basic cost of borrowing i.e. repo has not changed which may also hold for base rates and marginal cost of funds based lending rate (MCLR).

Can we expect rate cuts in future? It would be data-driven largely and since the RBI inflation outlook is pointing downwards with food prices likely to come down and the HRA component not exerting pressure, it cannot be ruled out. However, the RBI would see how the oil prices and exchange rate behave as that could have a bearing on the future inflation numbers. Otherwise, the risks are balanced to the lower inflation forecast made for H2-FY19.

There have been three noteworthy announcements on the development agenda which is of interest to the market. The first is the use of external benchmarks for denoting the rate on floating rates on retail loans and those to SMEs. This is an interesting position taken which will bring in some transparency in the structure though borrowers have to take a call on how these benchmarks like the 91 days or 182 days treasury bills move.

Second is the call to lower the statutory liquidity ratio (SLR) to meet the liquidity coverage ratio (LCR) norms. Bringing the SLR down in a phased manner to 18% works well because even today 15% can be carved out from the SLR for meeting the LCR requirement of banks. This is more technical in nature and may not release funds as such because banks are holding excess SLRs in their portfolio and would not really gain by the 150 bps reduction in this ratio. This cannot, however, be interpreted as a liquidity enhancing measure for sure.

Last, for the small and medium enterprises (SMEs), there would be a committee set up to work out ways for enhancing formal credit. This is timely and the recommendations would be eagerly awaited.

The way forward is to closely monitor the inflation numbers as they emerge which will be dependent on crude oil prices as well as the rabi progress. Non-food inflation has been high and a low headline number is due to the declining food prices. These two factors will hold the clue going ahead till February 2019.

(The writer is chief economist, CARE Ratings)

Also See: RBI policy updates: Repo rate unchanged at 6.50%; Urjit Patel says retreat in energy prices led to decline in inflation

RBI MPC member questions inflation data: Why there is nothing really amiss with the existing CPI methodology

Reserve Bank keeps interest rates unchanged, lowers inflation projection to 2.7-3.2% for H2 FY19 on normal monsoon

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