In a surprise move, the Reserve Bank of India (RBI) kept the repo rate unchanged at 6.50 percent - the rate at which it lends money to commercial banks. The reverse repo rate was also retained at 6.25 percent.
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When central banks don't deliver an expected rate hike, they are usually greeted by exhilaration in the markets. However, not this time. Reserve Bank of India governor Urjit Patel's no-hike policy was greeted with sinking stock markets and falling rupee. Only the bonds cheered mutely.
What probably rattled the currency markets was the RBI's assertion that its mandate is inflation targeting. The assertion somewhat left the market wondering who is in charge of stability in general and the external sector in particular.
RBI cut its inflation forecast -- a signal that higher crude oil prices and a weakening rupee may not have a huge impact on prices.
However, the RBI's stance has been changed from neutral to "calibrated tightening." So, rates hikes could be around the corner even if not right now.
Shares of non-banking finance companies (NBFCs) nosedived after RBI deputy governor Vishwanathan pointed at new rules over asset liability matches. He also said the mismatches of NBFCs will be written shortly. With the debt market already under pressure, this statement probably sparked off the sell-off in equities.
Patel emphasised many times saying that inflation targeting was a "legislated mandate" and one that the central bank cannot veer away from. This may have taken money markets by surprise because the MPC has an inflation-targeting mandate but the Reserve Bank was historically understood to be a full-service central bank that has financial stability as its core mandate.
CNBC-TV18 caught up with Pranjul Bhandari, chief India economist, HSBC, PK Gupta, MD, SBI and B Prasanna, Head - global markets group, ICICI Bank, to understand the implications of today's monetary policy decision on Indian economy.
Let me come to you first because of probably the philosophical confusion I had. RBI repeatedly said, or the governor repeatedly said that an exclusive mandate is inflation targeting and I was watching the rupee screen at that time. The moment that was said the rupee which has already weakened to 73.97 per dollar fell further to 74.12 per dollar. Is this a philosophical confusion that one thought the Reserve Bank would be responsible for the external sector as well and somehow it seemed to abdicate that responsibility?
Bhandari: Right, I am surprised that the RBI did not hike rates today. I was expecting a rate hike. But I don’t think it is inconsistent. They have been very clear that they are inflation targeters, they look at inflation.
Interest rates is an instrument to deal with inflation. Foreign exchange intervention is an instrument to deal with volatility in the foreign exchange markets. So, in that sense, there is no disconnect. I think the disconnect lies elsewhere. The disconnect lies in the inflation forecast. Our forecasts for the remainder of this year and next year are much higher than RBI’s forecast.
RBI has done a huge cut, 60 basis points for the near term and 20 basis point for later and that is where the disconnect lies.
At the heart of this disconnect is also how it is reading food and fuel. I think it believes that this food disinflation will continue for longer. I think what it misses out is that if food disinflation continues for longer now then food prices will become very low and next year food inflation will have to grapple with a low base. So, there will be more pressure for headline inflation. I do believe RBI is under-estimating headline inflation in FY2020.
I take that point, I will re-visit this issue of course, but that still doesn’t answer why the rupee fell some much exactly as the Reserve Bank was explaining that it is inflation targeting central bank?
Bhandari: That is very hard for me to tell, but I think there was an understanding in the market that rates will also be used to curb further depreciation in the rupee. I don’t think it was a right assumption that the markets were going with.
The RBI was clearly said they are flexible inflation targeter. You can only use one instrument for one objective. The instrument of interest rate is being used for inflation. They can’t use it for two objectives. I think that is something which the market did not realise and it has come as a shock today.
It is certainly variation from what central banks have historically done even if they have not said. They have used interest rates and used all policies for all goals. But this one has defined its goal more exclusively. Your key takeaways from the policy action and the statement?
Prasanna: You got the first point right. The most important takeaway from the whole policy is a fact that the RBI has clearly reinstated its inflation targeting framework, while not admitting to the fact that interest rates will be used as a tool for supporting currency at any stage.
My thoughts to the whole argument is that legislative mandate does not really override basic economics and we all know about the impossible trinity which is basically your capital flows, monetary policy and currency are interlinked to each other. So, globally there is an expectation that notwithstanding an inflation targeting framework interest rates typically are also used in the sense you react because you are not living in a vacuum, right?
You are living in a relative world where what other countries do also impact your flows and your macros. To that extent, I think the market was expecting interest rates to be used partly to support the currency.
I do agree with Pranjul Bhandari, however, on the inflation estimate that they did take into account cognizance of the fact that the realised inflation in the first quarter came lower substantially, so they have revised it lower going forward.
But was left unanswered was the fact that the rupee depreciation and the appreciation in crude oil over the last two months would leave a significant dent in the future inflation trajectory.
So, I don’t think our estimate is slightly much higher trajectory than what the RBI is projecting currently. So, to that extent for me, the biggest takeaway was the fact that they have not alluded to interest rates to be a tool for supporting the currency.
The second biggest takeaway for me was the fact that they are and rightly so very deeply concerned about the dislocation in the corporate bond market and the NBFC funding space. So, I see a lot of coordination between the Reserve Bank and the government in tackling the funding crisis arising out of the NBFCs scenario. That is a very good thing that has come out of this policy.
I guess the market was expecting and I would assume wrongly that because this is the monetary policy statement that some sucker will come for the NBFC sector. What they got was the deputy governor reading out the Riot Act and saying that you mismatched your assets and liabilities. If you were an NBFC investor, do you think now we should expect tighter regulations if anything and they are going to face a harder time?
Prasanna: The RBI might have been short on actions as far as this policy is concerned, but you should also realise that liquidity bazooka has actually been released even prior to the policy. They didn’t even wait for the policy. They actually did the FALL CRR increase from 13 to 15 percent hardly five days ago and they did the open market operations (OMO) calendar just hardly 3-4 days ago.
RBI is clearly mindful of what actions are required and once they are convinced that they want to be announcing election I don’t think they are wasting anytime to announce it. So, that apart, the crux of the problem as far as NBFCs are concerned is rightly identified by the Reserve Bank and I think that is the ALM policy of these NBFCs.
Equity market might not have liked what they heard from the Reserve Bank in the sense they are actually telling the NBFCs to probably they are going to come out with guidelines possibly going to be much more harsher on the ALM gaps that they are possibly allowed to be taking. But from a systemic perspective that is exactly the crux of the problem and it is good that RBI has identified that and probably any guidelines which come in that perspective might do something good for the long-term sustainability of the NBFCs.
First, your key takeaways, Gupta?
Gupta: As Pranjul and Prasanna mentioned the market assumed that rate hike primarily on account of the crude price increase and also the expected inflation that it would have brought in actually.
So, there obviously, the RBI’s own projection of the inflation going forward seemed to be much lower. My slightly different take on this is that RBI, the governor, did say that they have already done two increases.
They probably feel that those increases in the hike interest rates have already executed. So, the under-shooting of inflation in the previous quarter plus going forward if they really believe that the inflation is going to be lower than what they had expected in the last policy it itself then there is no need to increase the rates.
If you look at it if they are now expecting that the inflation is going to be lower than what they had projected and to take that into account they have already increased the interest rate. So, there was no logic to increase interest rates further. The market did expect primarily on account of the foreign exchange and the crude price increases.
They clarified that probably interest rate is not the tool they are going to use. Maybe, they will have some other tools to use. The stated policy has always taken care of the volatility.
But as a man who has to price money on a daily basis, price money for depositors and price money for your borrowers are you not left in a state of confusion which is what some other bankers told me – when the Reserve Bank in the August policy increased its inflation forecast for March from 4.6 to 4.8 and added a 5 percent for the first quarter it said it is at neutral in terms of stance. Now it has cut the inflation target and it has said that it is tightening, is not this a policy confusion? What will your next move be? Will you raise deposit rates or lower them? Will you raise lending rates or lower them?
Gupta: No, as far as the deposit and lending rates are concerned, apart from the policy rates, in terms of borrowings from the Reserve Bank of India or at the policy rates is very low. We are really depended on our deposits for funding our loan book. That is a function of the liquidity and the deposits that flow in to the bank also.
So, liquidity was an issue, about a fortnight ago we did see some tightening of liquidity there was taken enough action all that 2 percent FALLCRR as well as that OMO calendar so that didn’t release a lot of liquidity in to the system.
In fact, today, also if you look at it, on a syste-mwise we are liquidity surplus. So, if the liquidity continues to be alright I see no reason why the banks should really be increasing the interest rates.
Again if you look at the whole spectrum of banks there are some banks who probably have a little bit of tightening of liquidity but most of the systems still seem to be surplus and I don’t think there is any real concern there as far as rates are concerned.
What do you think is the next move for the banking sector? Will deposit rates go up and if yes how soon or will they not go up at all in the near future?
Prasanna: The deposit rates are going to be a function of the overall liquidity in the system. Like PK Gupta was pointing out, right now seems to be that enough actions have been taken by the Reserve Bank to supply liquidity which is required at the current point in time.
But we should also understand that going forward it is going to be a busy season where there is going to be a lot of credit growth happening as well as there is a season when the currency in circulation actually you see a seasonal hike in the CIC number.
From that perspective, system liquidity is going to take a hit and what would be of importance is whether durable liquidity is been provided by the Reserve Bank to sufficiently compensate for that. If it is not really the case then I would presume that it will be the responsibility for each of the banks in the banking system their asset-liability committee (ALCO) to meet and decide and figure out what kind of deposit rates that they should be quoting. I would expect the deposit rates to go up if enough liquidity is not provided in the system.
The inflation forecast according to the monetary policy report (MPR) is based on crude at $80 per barrel and rupee at 72.50 to the dollar. What is your own forecast, do you think that there will be an overshoot of the RBI's forecast and how many hikes are you penciling in?
Bhandari: It is only a matter of time before the RBI hikes rates and the change in stance makes that very clear. One other reason it did not hike rates today was its thinking around growth. For the first time, I saw the governor starting a press conference with 2-3 minutes dedicated to global growth. Also, the statement makes it very clear that they are much less optimistic about the investment cycle picking up than before.
Now that they have already given two rate hikes back to back, they can take a break from a rate hike. So, I think it is just a break at this point, it is only a matter of time that they hike again.
Coming to the inflation forecast, for FY20 the RBI has inflation forecast at 4.7 percent, we think it is going to be 5.1 percent. Even for the fourth quarter, our forecasts are higher than the RBI forecast and it is on the back of the fact that the rupee depreciation, oil prices and all of that are likely to impact headline inflation.
The RBI is assuming is that food disinflation continues for very long, they are expecting almost no impact from MSP. We are expecting a slightly higher impact than RBI.
How many hikes would you pencil in?
Bhandari: We have two rate hikes 25 bps each - one for December and the other one for the first quarter of next year.
We saw today a fairly decent rally in bond markets from 8.14 percent before the policy to a finishing number of 8.02 percent. Do you think this rally can continue or will it give away some of it?
Prasanna: The rally today was a big relief rally. The market was pricing in between 25 and 50 basis points. There were people who were suspecting that there could be a 50 basis points and mostly there was a unanimous opinion that there would be a 25 basis points, so from that perspective there was hardly any position that was really taken by traders going into the market and there were short positions which got covered post the policy. So, the rally was a reflection of that.
Having said that one important thing which is possible outcome of this policy is, it is quite possible that the direct link between the dollar-rupee and the bond prices opening every day is possibly broken for the time being because of the admission by the RBI that they are really worried about currency depreciation and using interest rates to defend that.
So, that linkage that was happening between the currency and the bond market might actually get broken a little.
There are factors that you need to be looking at on a daily basis like how global bond yields are going, as we speak US bond yields have already crossed 3.20 percent. We also need to look at the strength of the dollar against the other currencies, there are a lot of such factors which were going on. So, I would say a range of between 7.90 percent to 8.20 percent is a fair range going forward into this quarter.
I am giving 7.90 percent on the downside also because of the fact that the RBI has announced open market purchase calendar for the rest of the months and there are expectations like I told you earlier that much more liquidity is needed to be infused by the RBI going into November and December.
Since they have already shown us the way in October, there is some expectation that they would continue with that way in November and December as well, especially because the CIC leakage is quite high in this season.
From that perspective, the demand-supply of government bonds look a little better with RBI doing these open market purchases. So, we would look at a range between 7.90 percent and 8.20 percent.
What are you expecting on the currency and do you think the RBI will bleed more to keep the currency too volatile?
Prasanna: The currency argument is a little bit more complex. I think globally, investors were factoring in a rate hike because there were other central banks even within emerging markets who had actually hiked substantially more than what India had hiked.
So, to some extent, there could be a feeling that RBI is getting behind the curve as far as interest rate hikes are concerned. Doing a 25 bps hike today would have been the best par for the course in terms of being abreast with what the global central banks are doing. From that perspective, the currency market is a little disappointed in the sense that the hike did not come through and RBI seems comfortable with the current levels of the rupee though I do feel that they defended the rupee in the evening session today.
So, putting all this into a short story, I would say that it is possible for the rupee to depreciate and the dollar to appreciate a little bit more to the region of 74.50-75 if oil and other variables were to continue to be adverse to India.
There is a dislocation in the debt market. Where is the debt market today after the policy?
Gupta: The correction happened mainly because the market had priced in but I do not think anybody in the market is really looking at a very deep correction.
As Prasanna said it might go to 7.90 percent or it may not go there at all. However, I think 7.90 percent to 8.20 percent looks like a very fair range.
As the governor said any further moves on the interest rates are going to be only up, there is not going to be any down move. So, I think 7.90 percent to 8.20 percent looks like the range on the 10-year bond.
Do you think that money markets not funding NBFCs and especially some housing NBFCs, that dislocation has it got any worse or any better? As a debt market watcher, what do you feel after the policy?
Gupta: As far as the debt market is concerned, for the purpose of NBFC funding's as we discussed a few days back also, for the banks whatever proposals come we do look at it and we do the funding.
The deputy governor also mentioned that NBFCs have a capital adequacy ratio requirement which is much higher than the banks, they are at 15 percent but even though they have the capital but many of them probably have been running huge mismatches.
All their long-term loans have been funded by the short-term loans. So, obviously, there has to be some limit to it and their ability to refinance, again and again, they cannot grow at the rate which they have been growing. One major takeaway from this is that NBFCs cannot grow their long their long-term book by just taking short-term funding from the market.