expectations from RBI on 17th April

It is high time for shift into growth supportive monetary stance

The economic woes now revolve around growth and fiscal/current account deficit after significant dilution on inflation fears. RBI has been in anti-inflation monetary stance since March 2010 and now in pause mode since October 2011. RBI did series of rate hikes and maintained system liquidity in deficit mode to keep operative policy rate at higher end of LAF corridor, the Repo rate to arrest demand-push pressures on inflation. A combination of economic woes and monetary tightening through tight liquidity and high cost of liquidity has killed investor sentiment and consumer confidence; both considered critical for economic development. The downtrend in growth momentum is sharp (into 6%) against a very ambitious FY13 target of 7.6% while inflation is expected to stay below 7% with support from consolidation in crude oil price and rupee. It is high time for RBI to shift into pro-growth monetary stance; considered critical at this stage to address economic woes relating to growth and fiscal deficit. But for the liquidity over-hang in western economies and good appetite for BRICS, conditions in India would have been worse. It is important to set the house in order before recovery picks up in western economies which could reduce investor appetite from external sector. It is also important to create conducive environment to attract long term FDI flows for capacity build-up in core sectors which are considered critical to spur growth (and consumption) to address fiscal deficit through higher revenues.

RBI has two options on hand: one, to shift system liquidity from deficit to surplus mode and the second, to cut policy rates more aggressively than expected. A combination of both would be very aggressive; hence not expected at this stage. RBI would need to deliver minimum 75 bps CRR cut to drive operative policy rate from 8.5% to 7.5% keeping policy rates unchanged. The other alternate is to deliver 50 bps rate cut to maintain operative policy rate at 8.0% keeping the system liquidity in deficit mode within RBI’s comfort level. Having said these, RBI has another option on hand; to cut CRR and policy rates by 25 bps each to maintain deficit system liquidity below its comfort level of 1% of NDTL and operative policy rate at 8.25%. This can be viewed as “baby step” action before shifting into higher gears on getting more clarity on downtrend in inflation and stability in crude oil price and rupee exchange rate.

Our earlier expectation was for delivery of 50 bps rate cut in one-shot on 17^th April or in two phases in April and June 2012 for shift of operative policy rate to 8% before end of Q1 of FY13. Thereafter, to trigger next round of CRR cuts to shift the system liquidity from deficit to surplus mode to drive operative policy rate to 7.0% before end of Q2 of FY13. This will help to have smooth sailing of heavily front-loaded borrowing calendar and maintain adequate system liquidity mode at affordable cost before shift into busy season from October 2012. Now, a new dimension has emerged from expectation of aggressive CRR cuts from large PSU Banks instead of rate cut action. This would mean that system moves into operative policy rate of 7.5% straight away without the first pit stop at 8%; delivery of rate cut thereafter would then push the operative policy rate to 7.0%; our final pit stop. So, the question is do we shift from 8.5 to 8.0 and then to 7.0% (our expectations) or from 8.5 to 7.5 and then to 7.0% (derived from expectations from top PSU Banks)? We cannot ignore opinions of large players which will mean a lot to RBI.

How will RBI act on 17^th April? One thing is certain, it will not be status-quo; there will be delivery of rate cut or CRR cut or combination of both. It is very difficult to choose one from these three options. It is considered prudent to cut policy rates having lowered CRR by 125 bps in quick time. We would put a weight of 51% for 25-50 bps rate cut (without CRR cut) and 49% weight on 25 bps cut each on policy rates and CRR. It would be a pleasant surprise if RBI delivers 75 bps CRR cut to provide one-shot 1% downward shift in operative policy rate. Having said these, it is very critical to shift the system liquidity into surplus mode soon to address growth concerns and to create demand for Government Bonds to cut cost of Government borrowing.

What is the impact on markets? There will be sharp rally in the shorter end with 1Y Bond yield into 8% and 1Y OIS into 7.75%. On the medium to longer end, there will be release of pressure to guide 10Y bond yield into consolidation play at 8.25-8.50% and 5Y OIS rate into consolidation mode at 7.35-7.50%. The positive sentiments will also help stock market to get the focus back on NIFTY into 5630 and get rupee bulls back into street to trigger rupee rally into 49.80. All these will bring cheer into the Indian economy and asset markets. It is high time for RBI to act to prevent the worst and to get the economy back on track. Over all, do not prefer extension of pause mode from RBI which will be very bearish on markets and the economy!

Moses Harding