No long term risk on growth from macroeconomic fundamentals:
RBI shift to hawkish monetary policy stance since July 2013 was driven by conflicts in growth-inflation and Rupee exchange rate-interest rate dynamics. The major concerns (and irritants) were from elevated Inflation, high Current Account Deficit (CAD), and Fiscal Deficit pressure on the system. These concerns are no more relevant, as the trend (and long term outlook & expectation) has taken an U-turn, thus diluting the worries of RBI. Brent Crude long term stability at $40-65 is good for Inflation, Current Account Deficit and Fiscal Deficit, thus establishing Rupee exchange rate price stability. The huge pipe-line FDI flows and sustainability of long term FII appetite for India assets is good for growth, liquidity and domestic interest rate. Government is also on over drive to bring sustainable long-term resolutions to remove supply-side bottlenecks, seen as catalyst trigger to make tangible beneficial impact from dovish monetary policy stance to attract investments and spur consumption. All taken, macroeconomic fundamentals could only turn better from now on, with outlook for CPI at 4-6%, CAD at 1-2.5% and Fiscal Deficit at 2-4% of GDP, and it is imperative for RBI to turn supportive to push GDP growth momentum into higher end of 5.5-7.5%. The outlook on Rupee exchange rate, for long term stability at 58-63 provides the necessary band-width for RBI to ease rates, while retaining the operating Policy rate at Repo rate till expectations turn to reality!
Liquidity in plenty but rate pass through not significant:
Domestic interest rates have moved down since July 2013 across the curve; 1Y down from over 10% to sub 8.5% and 10Y down from over 9% to below 7.75%. Banks continue to hold huge excess SLR against mandatory 22% of NDTL. The rate pass-through is visible (and significant) at higher end of the pyramid, with large good-risk borrowers are able to access long-term funds at sub 9-9.5% while the small/medium enterprises continue to pay huge premium to lenders (to compensate for the squeeze from large borrowers). While the base rate will arrest extended advantage to large (and good credit risk) borrowers, further rate cuts will lead to cost reduction to small & medium enterprises through squeeze between base rate and actual rate. The external environment is strongly in favour of liquidity. Most of India Trade & Investments partners (Euro zone, UK, Japan and China) are seen to be in ultra-dovish monetary policy stance for extended period of time, while US appetite (for India) will stand enhanced post build-up of NamObama chemistry! RBI will stay in $ buy-mode to administer demand-supply equilibrium, leading to infusion of Rupee liquidity into the system. All taken, combination to manage excess system liquidity and to ensure effective rate pass-through across borrowers segment will put pressure on RBI to ease rates now with 25 bps with another 50 bps in April-September 2015, if cues continue to stay in favour!
Expect 25 bps rate cut with cautiously patience guidance:
The expectation was for 50 bps rate cut on or before 3rd February monetary policy review; got 25 bps ahead of policy date, and now expect another 25 bps on policy day. The guidance on the way forward will not be hawkish, but RBI is expected to trend with caution (and patience) seeking confirmation (and validation) on risk factors that could dilute the optimism and positive outlook. More importantly, the need is to divert liquidity from Gilts to productive assets to support economic capacity expansion, and create vibrant capital market to meet liquidity demand from core sectors that need to stay catalyst to spur growth momentum. The priority is to ensure availability of liquidity (to critical sectors) at affordable cost on matched maturity basis.
India financial markets have already built pipe-line rate-cuts, sovereign rating upgrade and optimism on growth pick-up through combined domestic and external participation. It is prudent for RBI to retain this bullish undertone (and pent-up euphoria) by delivering 25 bps rate-cut on 3rd February, which will be seen as all stake-holders in same pitch, and more importantly walking together! Will Rajan oblige? Yes, I believe!
Moses Harding
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