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The Reserve Bank of India on Thursday cut benchmark interest rate by 0.25 percent to 6.25 percent on expectation of inflation staying within its target range, a move that may translate into lower monthly installments for home and other loans.
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The central bank also changed its monetary policy stance to 'neutral' from the earlier 'calibrated tightening', signalling further softening on its approach towards interest rates.
In the first policy review under Governor Shaktikanta Das, the six-member Monetary Policy Committee voted 4:2 in favour of the rate cut, while the decision to change policy stance was unanimous.
Sajjid Chinoy, chief India economist, JPMorgan; Manish Wadhawan, head of fixed income, Global Markets, HSBC India; VS Rangan, executive director, HDFC and Dinesh Kumar Khara, managing director, State Bank of India, discuss outcomes of the RBI's MPC meeting.
A credit policy, a monetary policy which changes stance and gives a rate cut must be an economist’s pleasure. What are the key takeaways for you?
Chinoy: We are not particularly surprised. Our view was that they would change their stance and cut rates today. I think what you got from the MPC today was the reinforcement of what we got in October, which is that monetary policy is going to be conditioned on the legislated mandate, which is that it needs to be around 4 percent and all these are the risks that we talk about, which are meaningful whether they are fiscal risks or currency risks or oil risks, ultimately have to manifest themselves in current inflation or forecasted inflation for the MPC to response. I think that is a very important takeaway.
As you pointed out, the outlook has changed quite dramatically in the last six months, oil prices have collapsed and food prices are exceptionally benign. What that does is the outlook for inflation does remain benign. The RBI, as you said, has slashed its forecast to their credit marking to market regularly nowadays by another 70 basis points (bps) and inflation is going to remain below 4 percent for the foreseeable future. So I don’t rule out some modest easing, maybe another rate cut in the next quarter.
One basis point is a hundredth of a percentage point.
I think I will end by saying the key in terms of the monetary policy outlook is a year from now given this wide divergence between headline and core. Will headline converge to the core or will core converge to headline? The answer to that question will determine how much space, if any, the MPC has, for what it is worth. Our research shows that ultimately it is the headline that converges to the core. So we think as the year goes on, the space for any monetary easing will be foreclosed.
Finally, I am not so worried about growth. If you look at the stickiness of this core inflation, it tells us at least that output gaps are virtually closing. So I am a little bit more sanguine in terms of growth prospects and where the output gap is.
Putting together the outlook on inflation that Sajjid explained and that you could get from the inflation projections of the Monetary Policy Committee and the statements made on open market operation (OMO). What is your sense? Do you think OMOs will continue?
Wadhawan: The first part, definitely a positive surprise for the market because 90 percent of the people had expected a stance change but a rate cut is icing on the cake today.
Bond yields already reacted around 5-7 bps in the long end and the short end has gone down by something like 10 bps and that is the outcome of what you are saying that the maximum inflation during the current calendar year is not more than 4 percent. It’s up to 3.9 percent is what they are talking about. So an expectation of a rate cut further in April is still there and that is why markets are pricing at the short end.
Second, on the OMO, it’s not so straightforward because it said that we will maintain liquidity as per the requirements. I think the hint is towards that if the forex intervention is not very large and the liquidity remains neutral plus-minus 50,000 then the OMOs could be slowed down.
I think there was no commitment on OMOs for beyond February or for the next year. The only commitment was we will maintain the liquidity on a comfortable side and that is what market is factoring on at this moment. So what you can expect the market curve to steepen more, a bit more and then it stabilise as per demand and supply.
So what does that it mean in terms of the longer-term borrowing price? What will be the yield on 10-year, do you expect it to come down towards 7.3 percent or something as it factors in a rate cut when the next inflation number comes or do you think it remains stuck at the current levels?
Wadhawan: It is quite possible that you might see a range now which is around 7.25-7.50 on the new 10-year bond till March-end and then we get into the borrowing programme of April and then we see what happens in the policy. I think till policy you could see some drift down even further because there are OMOs lined up in February and the demand supply looks quite benign as of now for the current fiscal year.
7.50 percent on the 10-year bond would actually mean yields are rising, do you expect yields to rise?
Wadhawan: I said 7.25 to 7.50 percent it is a trading range, it is an outcome which is quite binary because after February the OMOs will stop then the genuine bond demand-supply will take over and at that point of time you could see an overreaction on the other side also.
You got the impression that OMOs will stop? How are you looking at the cost of money in the wholesale market?
Rangan: The rate cut by the RBI coupled with the forecast on inflation, directionally I would believe that the rates would be cheaper going into the closing of this year, As it was discussed that the G-Sec would probably be in the range bound of 7.25-7.50 percent and next year’s full budget and borrowing programme would obviously determine the course of action for the next year.
But for the time being as we get into this quarter-end and by end of this year, I believe that wholesale rate should soften from the current levels. It is a guess as to what could be the quantum but somewhere between I would expect 15-20-25 basis points is a possibility.
It may soften at the G-sec level but does it soften at a CP level because there are other problems that the debt market has?
Rangan: I would believe so. I would believe that it has softened if you look at the levels which were in September and my impression is that it would soften based on the current developments in the policy. It should soften a bit more. The levels could basis for discussion but broadly directionally it would soften.
A couple of bankers I spoke with after the policy said that lately marginal cost of lending rates (MCLRs) have actually been crawling up; we have seen them rising by 5 bps here and there. These bankers said that they may exceed rise in MCLR stopping but none of them thought that they have the elbowroom to cut deposit rates or for that matter lending rates. What would your position be? Do you think working capital lending or shorter term lending at least 3 year term loans can come at a cheaper rate for some companies that you lend to?
Khara: When it comes to deciding the benchmark rate; benchmark rate or for that matter the MCLR. MCLR, I will again mention the same thing; of course, it is a function of multiple things. The cost of credit which we have that has got a component of, if at all NPAs are high then provisions will be higher, it will have an impact on the cost of credit which is required to support the credit activity.
So that is the reason. MCLR whether it will come down or it will not come down apart from many other factors repo rate is one of the component and as I mentioned, much of it will depend upon the book of the bank, what kind of provisions they are required to make. So all those variables are there which have got an impact on the MCLRs.
More generally do you see anything in this policy and its projections, its tone that gives you the impression that credit growth will be better off this year, over the next two quarters?
Khara: The policy has very clearly articulated the concerns for the growth and the benign nature of inflation and how it is expected to be going forward for about a year or so. I would say that the policy is quite balanced when it comes to addressing the inflation concerns, inflation expectation concerns and also the growth concerns of the economy.
The policy has come out very clearly in terms of the impact of the global growth on the Indian economy that also is a very positive way of looking at things. It so appears that while the MPC has taken this particular decision they have kept these particular factors in mind while coming to this particular decision of cutting the rate and also changing the stance to neutral.
Given everything do you think the cost of money for a company like yours falls now, over the next two quarters will it be cheaper?
Rangan: The point is that you raised this issue about the change in the risk weight whether it will have an impact on the pricing, I just wanted to clarify that what has actually been changed in this policy or intended to be changed in this policy is about the core of the NBFCs which were in the asset finance and infrastructure.
They were already governed by the rating methodology as far as the risk weighting for the banks is concerned. What is getting included in the current scheme of things the proposed scheme of things will be possibly the loan companies, the companies which basically lend for various purposes and not necessarily in the asset finance category, so that section of NBFCs will get included along with the existing asset finance and the infrastructure financing companies.
As far as the housing finance companies are concerned, we were always based on the ratings as far as the banks were concerned. So, there is no change in the methodology of capital allocation for the banks vis-à-vis the housing finance companies is concerned.
They were always following this norm for the housing finance companies. From the point of view in terms of what you are trying to ask about the interest rate whether it will lead to a reduction in the interest rate by the lender, I would tend to agree that it is more about the generality of the rates if the overall rate system is coming down. I don’t think so specifically on the basis of this risk weight change as it is not going to change because it is already there in the system as far as housing finance companies are concerned and also some of the NBFCs are concerned.
Are these projections similar to yours, are you looking at inflation coming out as benign as under 3.9 percent for all of calendar 2019?
Chinoy: I think 2019 is a year of two halves. The first six months our forecasts are very similar to what the RBI has. Food prices remain very benign and the fact is oil is still in the low 60s and given the weight of food, we also look at an average of CPI in the first six months of 3.5 percent or below.
What happens in the second half I think is a function of various factors. One is what will eventually the stance of fiscal policy be this year, we have a full Budget in July, we are focusing very much on the consolidated public sector borrowing requirement. If that increases against this year and there is a positive fiscal impulse, that will have an implication for inflation projections down the line.
The second point that I made earlier which is a lot depends on where you think output gaps are and therefore whether headline converges to core or core converges to headline; we are of the view headline converges to the core. So later in the year, our inflation forecast is a little bit higher. The fourth quarter we do have inflation running above 4 percent.
So we think given that the focus is very much on the headline target, maybe in the near term given the certainty of forecast in the next three to six months, remember who knows where inflation will be a year from now and the standard errors around that are much larger. Given that we have got more visibility in the near term, maybe there is space for modest easing in the next quarter. I think what we are building in is one more rate cut.
They have given us new data in terms of household expectations falling rather seminally, by 130 basis points and therefore I am asking you, will you lower your own forecast?
Chinoy: Our forecasts are very similar in the first half of the year. We are holding on to our forecast in the second half of the year given what we find between headline and core. I would say on the inflation, this is positive, the household inflation expectations are coming down. I will just say that they are very influenced by food or fuel so these things do bounce around. If food prices move back up or fuel prices move back up, inflation expectations can easily go the other way.
You do not think that the fiscal pressures have been underestimated?
Chinoy: I think it is a bit early to say because as I have been saying, the center is a very small piece of the pie. So we need to look for what the full Budget tells us in July, what the states are up to and what the public sector is doing. If like last year we find that the public sector borrowing requirement is getting wider again this year, then that will have an impact on core and headline inflation down the line.
I wanted to ask you, we have a new man at the helm and he usually imparts his own tone to the MPC as the chair. What would you notice as a new tone of the new governor to the MPCs statement?
Wadhawan: Quite an interesting one. We were all awaiting for his official policy for the first time and I think that he has left his mark today on what he has done. From that point of view, you can clearly see that he is going to give equal importance to growth and inflation which is evident in the rate cut today, what he mentioned. On the other side of the fiscal part, what you were mentioning just now, I think we have to go by what he just mentioned that we have taken into consideration whatever is there and we believe it to be so.
I think beyond that, I would like to mention something here is the inflation projections. In our view, or in my view, this is the best what it can be achieved and I would say it is quite an aggressive projection what they have given for inflation for the second half. Nonetheless, because last six months have been such and you could air on this side also, we would wait and watch and I think I would allude to what Sajjid said that the second half could be a situation wherein if the growth is so high at 7.2-7.4 percent, what is being mentioned, you could see inflation inching up a bit from here what we have seen.
I would like to add one more point here which is an important takeaway from today’s policy because you were asking Rangan quite a number of times regarding the cost of credit or cost of funds. I think what today’s policy has done is that it has given in terms of what credit markets have been going through in the last 3-6 months. We have been hearing all kind of negative news of one or two or three, it gives some kind of space for the credit markets to start functioning at the short end at least and that is so important today.
I think that is the biggest key takeaway, a positive takeaway for the fixed income markets because beyond focusing on the 10-Year bond that forms a very large part of our economy and it is having a lot of impact in terms of pricing of loans and deposits what you talk about. I think that is a very important development what we are seeing. It will help the credit markets to function a bit more smoothly.
Do you see more lending in the wholesale markets?
Wadhawan: With liquidity liquidity being on the neutral side and with a further rate cut expectation if I may say so in the month of April and you should also see one more development is the FPI 20 percent rule that should actually help some of the FPI’s who have been sitting on the sidelines and not doing anything, so it could help companies which are on the AAA or AA segment. So, that is where I am coming from. This is a good enabler for funds to flow towards credit. I hope we will see the positive impact in the next few months.
What is the stamp of the new governor on his maiden policy?
Chinoy: They are going to take the legislated inflation mandate very seriously and monetary policy will be conditioned on the 4 percent target. They will continue to be data dependent. Number three they still worry about growth. They believe output gaps are negative now and despite strong projections of growth. We are a bit more sanguine that the core inflation signals are there is perhaps not as much slack as some may expect or believe.