Will RBI deliver to the gallery or yet another surprise?

RBI seen supportive to growth but suspect on delivery of rate cut

There is better clarity on macroeconomic environment since October 2012 Quarterly review. RBI had set certain benchmarks for shift into rate reversal cycle. There should be definitive signs of reversal in headline inflation; real interest rates should remain attractive to boost domestic savings; moderation in twin-deficits should lead (and pave way for) shift into moderate monetary policy; resolution to supply side bottlenecks to ease pressure on CPI inflation and dilution in strong headwinds from external sector on growth-inflation dynamics. RBI also considered low real interest rates as not major risk to growth. RBI is seen firm in its stance that loose fiscal and monetary policies cannot co-exist and derives comfort from tight monetary policy when fiscal policy is loose!

There has been lot of work done by the Government since then, having shown strong intent to address twin-deficits and accelerate off-shore flows into Indian debt and equity markets. The strong measures to contain fiscal deficit and to cut Current Account deficit will have beneficial impact on headline inflation over medium to long term. The intent to remove fuel subsidy, discourage non-essential imports, reduce consumption of essential imports, provide greater comfort to off-shore investors, preparation of road map for reforms in land, tax, legal to lift underperforming core sectors etc are some of the measures that would give good comfort (and confidence) to RBI who is seen to be prepared for moderation in monetary policy to support growth but there are minor irritants that RBI may not wish to ignore!

Policy rates: huge expectation build-up for 25 bps rate cut, will RBI deliver?

The market is seen to be very confident of rate action on 29^th January post weak November 2012IIP data and encouraging December 2012 WPI headline number despite retail CPI inflation print edged up into double-digit! The headline WPI inflation print at lower end of RBI’s tolerance zone of 7.0-7.5% and weak IIP numbers has built near consensus expectation of rate cut this time. However, concerns are from spike in retail CPI inflation print at above 10% and further pressure (in the near/short term) from fuel price hike and higher commodity prices. The headline inflation numbers are not going to trend into RBI’s comfort zone in a hurry. RBI is also seen comfortable with current interest rates; opening up of dollar swap window (and resultant elevated FX premium) will arrest sharp downtrend in 3-12M money market rates; rate cut at this juncture will only build steepness in the rate curve with downward shift in the near end tenors of overnight to 1 month. The benefit will accrue to those who run negative structural liquidity gaps (in the 1-28 day time buckets) while hurting those who provide liquidity in the shorter end. Taking these signals into account, stake holders have already given up expectation of 50 bps cut in policy rates with many in favour of 25 bps rate cut while some (minority, of course!) fear a pause from RBI. There is merit in RBI taking a wait-and-watch stance on the last quarter review of FY13 to get more clarity from Budget FY14 on growth and fiscal deficit estimates while staying fingers crossed on inflation and Current Account deficit. RBI cannot ignore the “price heat” on the ground for majority of the population and the need to maintain interest rates high till supply side bottle-necks are removed. It is a tough call to choose between 25 bps rate cut and pause mode. RBI has never delivered to the gallery and prefers a path which is best suited for the economy (priority over inflation control for long term beneficial impact on growth) rather than the markets. There are signs that FM is prepared to wait till moderation in fiscal position is sighted. The “aam aadhmi” factor and insignificant impact on short/medium term rates may warrant pause stance this time and defer rate cut to March/April with option to deliver one-shot 50 bps if irritant factors are out of the way. MARKET PULSE stay neutral unable to choose between the two while ruling out 50 bps rate cut, with gut feel expectation of pause!

Liquidity: no change stance on CRR

The reporting fortnight average Rs.75-80K Crore drawdown from LAF counter may not be a worry for RBI when system excess SLR is to the tune of Rs.5 Trillion. The concern for RBI will be on how to pull this excess into its books and divert the cash for on-lending to productive sectors. RBI would need cash (in its balance sheet) to fund its OMO Bond purchases and USD purchases to shore up its FC reserve position. RBI may prefer to deliver CRR cut in March mid-quarter review to cover tax outflows rather than now when the need is limited. It will be good for the Bond market if RBI prefers OMOs instead of CRR cut for liquidity injection. With most banks posting higher NIMs, the benefit from 25 bps CRR cut is insignificant at this stage. MARKET PULSE expects an unchanged stance in CRR.

Other agenda: concern on credit growth and divert liquidity to productive sectors

RBI’s is expected to address flow of credit (and liquidity) to productive sectors and development of vibrant corporate bond market. The current deposit and Credit growth is reflective of economic growth trend, deposit growth at 2.5 times and Credit growth at 3 times of the GDP growth. The concern is from excess SLR being funded out of deposits and not entirely from the Repo counter. There is general risk-aversion and good quality credit is at very low premium to sovereign yield, hence the pile up of excess SLR ahead of rate reversal cycle. The need is to make use of these funds through intermediaries (with better credit risk profile) with SLR status (if covered under sovereign risk). The development of corporate bond market needs active participation from commercial banks. Banks would need access to longer tenor source of funds being already under pressure funding SLR and longer tenor loan book with longer tenor deposits/liabilities. MARKET PULSE will look for some actions in these critical areas.

Post policy impact on markets:

The near term trading range is firmly in place; asset markets rallied in anticipation of 25-50 bps rate cut and has already unwound part of the gains on fear of RBI not delivering to expectations.

·       10Y Bond yield is expected to trade at 7.80-7.95%; into lower end on 25 bps cut and into higher end on pause. The tone of the policy will provide signals for directional break-out. While 7.80% is expected to stay firm, there is risk of extended weakness into 8% if investors choose to trim excess SLR for realisation of profit for FY13.

·       USD/INR trading range is seen at 53.10-54.10; into lower end on 25 bps cut and into higher end on pause. While bearish expectation on rupee is diluted on aggressive measures to cut Current Account deficit and to bridge the gap from capital account flows, risk of intra-2013 weakness to 56 will provide solid support to the dollar at 52.60-53.10. On the other side, weakness to 53.85-54.35 will look good for exporters to cover 3-12M dollar receivables.

·       NIFTY trading range is seen at 5980-6180; into higher end on 25 bps cut and into lower end on pause. The bullish undertone with intra-2013 target at 6400, weakness will find solid support at 5980-6005.

Let us see what RBI does; deliver to the gallery or spring yet another surprise!

Moses Harding