Comment on the RBI Monetary Policy Statement

Feb 04, 2015

Before :

Ten year yield: 7.64%

Rupee: 61.78
After:

Ten year yield: 7.71%

Rupee: 61.69



Summary: As expected RBI kept the benchmark rates unchanged while reducing the SLR rates by 50 bps to 21.50%. The guidance remained the same as that given on Jan 15 2015 at the time of Repo rate cut of 25 bps to 7.75%.The RBI chief Rajan cited no change in the current inflation pattern and is looking to fiscal numbers and the Budget, a confirmation of the continuing disinflationary trend and the recalibration of the GDP numbers on Feb 9, for direction. However as always, he continues to make structural changes and improvements in the system, some of which are highlighted below.
  • Repo rate remains unchanged at 7.75%
  • Reverse Repo rate and MSF rate unchanged at 6.75% and 8.75%
  • CRR rates kept unchanged at 4.00%.
  • SLR rate cut by 50 bps to 21.50% from 22%, to give more headroom to banks to expand credit.
  • Cap on overnight LAF Repo at 0.25% of NDTL maintained. RBI plans to continue with 7-day and 14-day term repos at 0.75% of NDTL
  • Overnight variable rate repo and reverse repo would continue as a means to manage liquidity.

Key Takeaways:
  1. External vulnerabilities on account of the global deflationary environment, especially in the Eurozone and China, remain. Certain economies have benefitted from the fall in oil prices but consumption pick up remains slow. The report seems to suggest a high probability that oil prices will not remain at these lower levels for long.
  2. RBI warned about upside risk to the inflation on account of factors like fiscal slippages, irregular monsoon, pull back in global crude prices and possible rupee depreciation.
  3. Flexibility given to banks on recasting of loans where there is change in management and also where loans are being converted into equity. Bankers opine that this move is likely to improve liquidity in the markets.
  4. FPI’s allowed to reinvest their coupon proceeds in G-Secs since the current investment limit of $30 billion is fully utilised. The long term window of $5 billion though is still available. Additionally RBI has clarified that FPI’s can only invest in corporate bonds with a residual maturity of three years plus. Clearly the signal is that RBI is not interested in “ hot money” investments
  5. Additionally, FPI’s and individuals have been allowed to purchase USD/ INR future contracts to the tune of Rs 15 million per exchange without proof of underlying exposures. Positions in EUR/ INR, GBP/ INR and JPY/ INR will be allowed to the extent of Rs 5 million without underlying. This is probably a move to stem excess speculation in the NDF market which had impacted rupee stability in the last couple of months.
  6. Going by the success of the 10 year IRF contract, the RBI has allowed the introduction of the 5 year and 15 year IRF contracts by the end of March 2015.
  7. RBI has forecasted the real rate of GDP growth in the next year could be close to 6.5% but will wait for GDP recalibration on Feb 9 for certainity. It expects that CAD will drop to 1.3% of GDP this year. Continuing its move to end specific subsidies it will do away with Export Credit Refinance Facility. Starting Feb 7, the RBI will merge the same into System Liquidity provisions.
  8. There has also been some relaxation of limits for individuals under the LRS scheme, which now allows them invest $250,000 abroad versus the earlier$200,000.
  9. Lastly banks have been allowed to accept deposits which do not allow pre mature withdrawal
In conclusion, RBI is holding out till the Budget is released to understand how much room they might have to cut rates with an eye on the quality of fiscal consolidation. We do not feel there would be any impact of the 50 bps cut in the SLR rate which amounts to aroud Rs.40,000 – 50,000 cr of NDTL as the investment deposit ratio continues to be as high as 29.65% and will continue as long as the investors remain bullish on G-sec.

The fiscal deficit numbers may be the immediate cause of worry for Rajan as the Apr-Dec 2014 deficit numbers stood at 100.2% of the full year budgeted estimates. With the crude pirces mostly bottoming out and the MoF’s struggle to meet the Revenue targets for FY14-15 it is looks less likely that the RBI may cut the rates in the next policy meet. The markets too reflected a similar sentiment as the 10-yr g-sec reacted by around correcting around 6-7 bps, whereas the Bank Nifty fell by over 500 pts but recovered partly later on.



Call Ritesh Bhansali, on our CF deskat 9869807335 or email ritesh.bhansali@mecklai.com to find out more.