Retain caution on inflation expectation
Post the front-loaded 50 bps rate cut on 29th September review, status-quo was expected on policy rates and liquidity ratios. Thankfully, the delivery was to unanimous expectation.
The expectation was from RBI outlook and expectation on the GDP and inflation. While RBI is seen to be in comfort on FY16 GDP target at 7.5%, RR remain suspect on CPI retaining FY16 target at 5.5-5.8% with marginal improvement to 5% by end FY17. RBI has taken into account possible reversal of trend in commodities in 2016, weak Rupee against strong USD against global currencies and supply side bottlenecks to absorb higher consumption demand leading to elevated prices on essential items. This outlook on inflation sets aside next round of rate cut in the near future, in any case not before June 2016. While remaining suspect on inflation, it is not fair to expect RBI to cut CRR or SLR or shift operating policy rate from Repo to Reverse Repo rate during this period. All taken, RBI monetary policy stance stay accommodative on policy rates (with limited room for more cuts) and vigilant on liquidity (retaining operating policy rate at higher end of LAF corridor).
Resolutions to Banks Balance Sheet woes not clear
While RBI provides top priority to resolutions to NPA woes of the Bank to make them fit and strong to feed into higher credit demand from growth momentum, more focus is on the revised Base rate application by Banks. The lending rate fixation is factor of risk - reward and demand versus supply against the incremental cost differential between outgoing deposits and incoming funds. RBI also took comfort from relaxation in off-shore access to domestic borrowers. The shift of demand from domestic to offshore may not be to the liking of domestic lenders leading to cost advantage only to good risk borrowers, while high risk wholesale borrowers in core sectors continue to struggle for funds willing to pay higher credit premium. Who will share the burden of Banks NPA restructuring strategy? There was no clarity on this, as Banks do not have the Capital or P&L bandwidth to do it on their own.
Way forward is bumpy against FED rate hike
The short/medium term outlook is nervous when India operating policy rate stay steady at 6.75% while US FED Fund rate may inch up to 1% by mid 2016. Against this policy rate outlook, sub 1% inflation in the US against 5-5.5% in India is not positive for India Financial markets. While nothing to expect from RBI in the next 2 policy review in February - April 2016, all attention will be on the FED on quantum of rate hike and on ECB for timing of end of QE, expected to be ahead of schedule. All taken, foreign appetite on India risk-on assets will stay low. Will domestic appetite bridge the gap to aspire for 12-15% rally from here back to 2015 high by end of 2016? Dunno, fingers crossed!
Having done the devil's advocate, BJP is seen to get the opposition together on policy reforms. If the pipeline initiatives are put into execution mode at faster pace, India may get the attention and appetite of foreign investors. I could only wish for the best to get the euphoria on NaMo back on track which drove the markets crazy between May 2014 to March 2015.
Over all, there is nothing much to cheer from the policy review. The take-away is the recognition of the downside gloom from domestic and external dynamics without clarity on ring-fence to retain the economy in sustainable growth track and dilute the pent-up nervous undertone on India risk-on financial assets.
Good to end with caution to stay vigilant on the financial markets for better balance of risk-reward, awaiting better clarity from the mid-December FOMC review.
Moses Harding
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