RBI keeps policy rates, reserve ratios unchanged, joins policy inaction bandwagon
Assurance on liquidity; Odds increase for a 50bp rate cut in Jul-12
- RBI left most things unchanged - policy rates, reserve ratios, its growth, inflation and monetary indicators, as well as its policy stance.
- However, it enhanced the export credit refinance limit for banks from 15% to 50% hoping to infuse Rs300b, equivalent of a 50bp cut in CRR.
- As one of its various rationale for policy status quo, RBI mentioned real effective lending rates are positive but lower than the boom period of 2003-08. It, however, left unclear as to how the present economic situation is anyway comparable with such a reference point.
- Among other factors behind holding rates, it pointed out i) the possibility of INR depreciation expanding external demand; ii) divergence between WPI, CPI and core inflation; iii) inflationary overhang of incomplete pass through of oil price; iv) liquidity softening on account of OMO and now enhanced limit for export refinancing. Each of these propositions are, however, debatable.
- A few extraneous considerations that might have played a role include i) assertion of independence and autonomy as pressure for significant easing were built up both from government and the market, ii) once in six-week policy leaving enough headroom to adopt an 'wait and watch' policy particularly in view of unfolding global events like Greece elections, US Fed and G-20 meeting, etc.; iii) possibility of new policy direction from and coordination with new finance minister.
- The pause in Motilal Oswal's view is significantly negative and reflects considerations for stabilizing INR by keeping interest arbitrage high to attract debt capital flow. This also means that deflationary bias of monetary policy would continue if QE type measure is initiated in the West.
- Overall Motilal Oswal hold that the odds have increased of a 50bp rate cut in July 31st policy review along with a downgrading of growth estimates. Unscheduled and bigger cuts are not ruled out contingent upon unfolding events.
RBI spoofs the market by joining the policy inaction bandwagon
- Policy rates left unchanged: Somewhat unexpectedly, RBI kept key policy rates unchanged (25bp cut expected by MOSL/Consensus). Thus, Repo rate stands at 8.00%, Reverse Repo at 7.00% and MSF/Bank rate at 9.00%.
- CRR unchanged at 4.75%: RBI left the CRR unchanged at 4.75%; it had last cut the CRR by 75bp on March 9, 2012. The SLR ratio was left unchanged at 24%.
- Growth inflation estimates left unchanged: RBI left its growth estimates for FY13 charted out in Apr-12 unchanged at 7.3% and Mar-13 inflation estimate at 6.5%. Monetary projections, viz, M3, deposits and credit growth rates too were left unchanged at 15%, 16% and 17%, respectively.
- Enhancement in export credit limit: RBI increased the limit for export credit refinance from 15% of outstanding export credit of banks to 50%. RBI claimed this increase will potentially release additionally liquidity of over Rs300b, equivalent to about 50bp reduction in the CRR.
- No explicit recognition of change in policy stance: RBI did not indicate any change in its policy stance while emphasizing the need for liquidity. In its guidance too it alluded to continued OMO support.
- Stands ready for adverse global situation: Finally, recognizing that the global situation is turbulent, the Reserve Bank stands ready to use all available instruments and measures to respond rapidly and appropriately to any adverse developments.
Key takeaways of a status quo policy
i) Significantly negative: Motilal Oswal hold that the pause in easing of monetary policy in sharp contrast with expectation was a significant negative for the market. Whatever considerations might have gone into making of the decision, it undoubtedly would complicate growth situation further.
ii) External concerns run paramount: Motilal Oswal suspect the real reason for holding rates and reserve ratios is the predominant concerns from the external sector. Any cut in the interest rates would reduce the artbitrage opportunities opened recently by liberalizing debt capital flows, putting further pressure on Rs. However, this means a fundamental shift of policy toward management of exchange rate, and secondly inflation at further cost to growth. This implies a rather risky trade-off of long-term growth potential for near term stability. If today's fall in Rs is any indicator it may do little to restore confidence on the external front too.
iii) Fear of QE-III looming large: RBI also alluded to the risk of further quantitative easing in the west on domestic inflation. This also means a continuation of deflationary policies in order to stem imported inflation.
iv) Expect 50bp cut in policy rates in July 31st: Motilal Oswal believe (or at least hope!) the current pause is temporary, and expect RBI to stay on the easing course for remaining FY13 as indicated in its Apr-12 policy stance. Thus, they believe odds have increased for a 50bp rate cut in the July 31st policy announcement. They also expect that the growth estimate of 7.3% for FY13 would be revised downwards simultaneously while keeping Mar-13 inflation estimate static at 6.5%.
v) Unscheduled or bigger cuts not ruled out: Motilal Oswal, however, hold that as in the last four occasions, the element of surprise would be retained in policy making as increasingly a faltering economy is making monetary policy a one-way bet. Also, the uncertainties emanating from the global economy may warrant swift and large policy action, contingent upon such an event.
vi) Uneasy feel of policy paralysis adds up: Along with government, the policy paralysis now seems to have permeated RBI too. This also means rather a lost opportunity to pep up growth that seems critical to stabilize the financial markets, including credit rating. Arguably the policy paralysis at the government's end involve much harder considerations for deliberations for such areas like foreign participation in retail, land acquisition or even oil sector reform - than tweaking monetary policy rates. To that extent, the current policy inaction negated recent optimism and the market rally on the back of a dim ray of hope.
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