Calls to cut policy rates get louder
There is pressure from the Government and wholesale borrowers for more (and accelerated) cuts in policy rates. The borrowers logic is based on their inability to compete with off-shore peers where the cost of funds is very low. The huge difference in interest cost (between on-shore and off-shore markets) cut their competitiveness adding pressure on top-line capacity building. True, makes sense!
On the otherside, the Government is not keen to retain the interest rate advantage play to off-shore investors for extended period of time. It is fact that leveraged off-shore flows gets into the system for the elevated yield spread against Rupee exchange rate stability. The system has witnessed sudden bout of weakness from herd-unwind of such fair-weather hot money investor community. This time, most stake holders are seen to be ok with sudden bout of weakness, seeing this as blessing in disguise to attract stable value-buy long term investments, while seeing Rupee depreciation (reflecting fair valuation) as good for exporters. Given the benefit from Brent Crude stability at $45-60 and dilution in risk of CPI stability at higher end of 4-6% tolerance zone, Rupee impact on inflation can be easily absorbed if significant benefit accrue to boost exports and replace hot money with stable FDI inflows. So, when twin-deficits and Rupee exchange rate are not seen as structural woes on inflation, seen against sharp soft landing of July CPI below 4-6% tolerance zone (at 3.8%), there is indeed strong case for delivering token 25 bps rate cut now, ahead of 29th September policy review.
Dream-come-true July CPI print is manna from the heaven
None would have expected the July CPI print at 3.8% below the set long term tolerance zone of 4-6%. Most stakeholders opined risk of stability at higher end at 5.5-6.0% in the short term. RBI was also in this crowd with January 2016 target at 6% and March 2016 at 5.8%. Against these estimated outlook, CPI at 3.8% is great relief (to counter the China Exchange rate actions). Even if some critics see this in disbelief and tough to sustain, positive take away is from expectation shift from 5-6% stability to 4-5%. This scenario sets up operating policy rate (now Repo) range at 6-7% at higher end of RBI stated target of 1.5-2.0% spread between policy rate and CPI expectation. Even if RBI wishes to wait and watch through September awaiting August CPI print and mid September FOMC meet (on FED start of rate hike), it can well afford to wait post delivery of 25 bps rate cut, reducing the Repo rate from 7.25% to 7.0%.
While this act is not seen as a significant beneficial impact for borrowers, it is good for RBI in many ways.10Y bond yield stability at 7.70-7.85% is good for smooth conduct of rest of FY16 Government borrowing schedule and conduct OMO bond sales to arrest excessive decline in medium/long term yields. The build-up of steepness in the overnight-10Y sovereign yield curve at 7.0-7.75% may not hurt retail investor community. All taken, a cut of 25 bps now (may be, this Friday as Independence day gift to the nation) is the way to go!
Impact neutral on markets
The Indian markets are weak both from domestic and external cues. China currency war to support export-driven economy is not going to stop; more devaluation to come! On the domestic cues, while there is great comfort now from twin-deficits, growth concerns remain given the struggle to push key policy initiatives. Add to this, the downside risk on the Rupee will make FIIs look for exit door from India (and emerging) markets for safe return home. The rate cut now will help to dilute this bearish momentum for price stability.
All cues taken, pre & post rate cut range is seen for NIFTY at 7950/8100-8500/8650 and BNF at 17100/17500-18700/19100. An early rate cut will provide stability at upper-half of set ranges; while a delayed one, post move into the lower end (of the inner-ring) will get the focus at lower-half of set ranges. At this point, expectation of rate cut is holding NIFTY at/above 8315-8350 (Bank NIFTY at 18000-18100), while a delay could extend the bearish momentum into 8100 (17500).
USD/INR move into higher end of 64.50-66.50/67 is seen good for adjusting the Rupee over valuation to fair-value to remain competitive for India exporters (against China onslaught) and attractive for fresh flow of FDI flows into India.
India 91-364 T-bill yield shift to 7.15-7.40% is good to get the shorter end of the yield curve down for benefit of borrowers, which would improve demand (and consumption) for higher capacity usage and expansion. 10Y yield stability at 7.70-7.85% is good for the Government (lower cost on borrowing), long term retail investors (yield stability despite rate cut) and RBI (for smooth conduct of pipe line auctions).
Why wait, then? Get it out on 14th August!
Good luck, tighten your belts for price volatility!
Moses Harding
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