The Last Of The Rate Cuts, For Now

The Reserve Bank of India (RBI) has kept its policy rate unchanged at 6% and the stance of the October monetary policy continues to remain neutral, but the rise in the Indian central bank’s inflation projection for the second half of fiscal year 2018, marginally though (from 4%-4.5% to 4.2%-4.6%), makes any cut in the December policy uncertain.

We may have already seen the last rate cut in August. Or, the wait for the last rate cut gets longer if one reads the latest policy document carefully. RBI can cut the rate if only there is a dramatic drop in economic growth. The growth figure for the September quarter will be announced on 30 November.

RBI has brought down its projection of the real gross value added (GVA) growth for 2016 by 70 basis points—from 7.3% to 6.7% with risks “evenly balanced”.

While this is on the expected line (my previous column spoke about a 75 basis point likely cut in GVA) the market was a bit surprised at the upward revision of the inflation projection even though it takes into account the rise in house rent for central government employees. This is why bond yields rose. Bond yield and price move in opposite directions. One basis point is a hundredth of a percentage point.

I would like to believe that the document is less dovish than what many had expected. It clearly says even though the inflation figures till now have been broadly in line with projections, the extent of the rise in inflation, excluding food and fuel, has been higher than expected.

Uncertainties have been intensified by 5% deficit and uneven distribution of monsoon which will have an impact on the kharif production, price revisions on many items following the implementation of the goods and services tax (GST) and the rise in international crude prices.

On top of these, farm loan waivers by a few states and the likely salary rise of state government employees could push up inflation by another one percentage point in the next 18-24 months. If indeed that happens, we may have already seen the last of the rate cuts.

RBI is also concerned about the shoddy implementation of GST and says it may further delay the revival in investments in an economy that is already facing hurdles on account of the so-called twin balance sheet problem—that of over-leveraged companies and banks burdened with bad loans.

RBI will continue to watch the inflation trajectory for months before taking a call on the next rate cut which can only happen if growth drops much below its annual projection.

Even a drop in the second quarter may not move the central bank to act; it may like to wait and watch at least till the December quarter growth figures are out.

It has also voiced its concerns against any fiscal stimulus. With a 6% combined fiscal deficit (of both the Centre and the states) any stimulus at the cost of fiscal deficit will undercut macroeconomic stability.

Instead of fiscal stimulus, RBI has suggested a few measures to prop up growth in Asia’s third largest economy. Its prescription includes:

Recapitalisation of the public sector banks adequately (this will ensure credit flows to the productive sectors);

A concerted drive to build infrastructure; restarting stalled investment projects, particularly in the public sector;

Enhancing ease of doing business, including simplification of GST;

And, ensuring faster roll-out of the affordable housing programme with time-bound single-window clearances and rationalisation of excessively high stamp duties by the states.

Some of its regulatory measures taken outside the monetary policy for faster transmission of the monetary policy and deepening financial markets are significant.

It is planning to link the marginal cost of funds based lending rate, or MCLR, to an external benchmark to make it uniform for all banks. And, more importantly, the banks will be required to reset the loan rates every quarter, instead of annually which they do now.

In a low interest regime, this will help the borrowers and dent bank’s interest income.

Another significant market development is allowing short sellers of government securities to dip into the kitty of bonds held in the so-called held-for-trading/available-for-sale/held-to-maturity portfolios and not borrow securities from other banks. This will smoothen settlement of short sale transactions.

A short sale is a transaction in which a trader sells a bond which it does not own. So, the trader borrows from others to meet its delivery obligations to the Clearing Corp. of India Ltd (CCIL), which runs the bond market, till it buys the bonds and squares off the position. When there is a lack of supply of the bond which the short sellers need to borrow, a short squeeze happens.

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In March and April this year, public sector banks, led by a very large bank, refused to lend bonds to the foreign banks and primary dealers for covering their short position even though the short sellers were ready to pay a hefty price for it. This could have led to defaults.

Short selling is the lifeblood for the development of any securities market as it creates liquidity and helps in price discovery. The new norm will come in handy for this.

Finally, RBI has decided to allow state governments to reissue their debt papers. Unlike the central government, the state governments till now do not reissue their papers; they always go for fresh issuance of debt. Also, instead of a fortnightly bulk borrowing from the market, the central bank now wants states to borrow weekly.

Many of the state government bond auctions in recent times “tailed”. The “tail” refers to the difference between the highest yield on a paper during an auction and the expected high yield when the auction starts. The combined move will create more liquidity and bring down the yield on state government papers.

This column first appeared in www.livemint.com

To read the author’s old columns, please log onto www.bankerstrust.in

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank.

His Twitter handle is @tamalbandyo.