RBI policy: No news is good news for market players. Here's why

The RBI was not expected to do much on the rates front and hence a no-change stance taken in its monetary policy review does not come as a surprise. The RBI has spoken of an informal band of net interest rate in the range of 1.5-2%, and with CPI inflation at 5% and repo rate at 1.75%, we appear to be within this band of comfort. The interesting part of this no-change stance taken this time is that in the earlier two policies in August and September the conditions guiding the policy decisions as stated in the policies were the same and have remained unchanged. [caption id=“attachment_2437596” align=“alignleft” width=“380”]  AFP[/caption] First, expected inflation was to increase in the earlier policies which have materialised this time. Second, the uncertainty on Fed action was at the top of the mind, and while it looks likely that it will happen this time, there is still a question mark as of today. Third, global economic volatility existed earlier and is there even today with a Chinese slowdown, quantitative easing in Japan and euro region and possible tightening in the USA. Yet the response of the RBI has varied – it was ‘no action’ in August, ‘50 bps cut’ in September, and ‘no change’ on December 1. The lesson is that monetary policy will always carry a surprise and cannot be easily interpreted against the environment. The RBI is still critical of the transmission of its rate cuts of 125 bps through the year which has led to a decline of only 60 bps in base rates of banks. However, if reckoned over the financial year so far, there have been 75 bps cut in repo rate with 60 bps in base rates. Hence, the gap has narrowed down where banks have lowered their base rates urged by the RBI as well as the market as the latter was quick to react to the rate cuts in terms of transmission. Borrowers are quite clearly better off as they have been able to source funds at a lower rate – either through banks or the market for CPs and corporate debt. However, with lower rates, we have not quite seen a significant pick-up in bank credit or for that matter even overall flow of funds including bonds and CPs. There is evidently an issue on the demand side where household expenditure is still under pressure of food inflation which has come in the way of spending. The GDP numbers released for Q2-FY16 show that the share of consumption has come down in GDP indicating low demand conditions. This is probably why there has not been a very significant pick-up in demand for funds. The RBI data also points towards surplus capacity in almost all industries to the extent of 25-30%. One segment which will continue to benefit is the real estate sector as evidenced by the GDP growth numbers and supported by bank credit in the mortgage segment. It may be pointed out that even in the past when rates have been cut by the RBI, the mortgage rates were quick to respond. This is probably good news as housing has the ability to propel the economy and with the government being the only other entity which can spend, resurgence in this area has strong backward linkages too. How about household savings? No change in interest rates is good news. However, with the earlier cut of 50 bps, deposit rates have come down which combined with rising inflation especially on the food side has put pressure on overall savings as a larger part of the income is being used for financing necessities. This could be one reason as to why the RBI has not gone ahead with another cut in rates as it has been observed that financial savings have been moving down of late. Towards the end of the policy statement, the RBI has once again reiterated its concern over small savings rates not being aligned with the market and the necessity to have the government review the same. This again may not be a good signal for the households. What is the future direction of interest rates? The direction is clear which is southwards as even though inflation will be increasing in the next couple of months, it is unlikely to breach the 6% mark to cause a turnaround in stance. However, the pace of rate cuts will vary with circumstances. While another 25 bps cut may be expected this year if all goes well, the Union Budget and its content will probably hold the clue as the Pay Commission would come into effect next year fully which while having a positive effect on spending can generate demand pull forces which have been absent for some time now. Today the two main concerns are inflation and the Fed rate cut. Inflation will be guided by developments on food supplies and the present rabi sowing numbers are slightly below satisfactory. Once the Fed lowers rates, there will be a tendency for investors to move back to the USA which can accelerate the process of withdrawal of foreign funds from emerging markets. In India too we have observed FII flows turning negative in November after moving into the positive territory in October following 2 months of negative inflows. An environment of declining domestic interest rates and increasing global rates (USA) would compress these flows further. Is no news, good news then? Yes, or so it appears as maintenance of the status quo does not change anything as such for market players. It needs to be seen how growth behaves in the next few months and the rabi crop can hold the clue to future food prices. The policy review may be interpreted more as a summary round-up of the economy which also highlighted the concerns, which again are well known. No direct clues have been left for the next policy and hence to use the cliché, one needs to wait and watch. The author is chief economist, CARE Ratings. Views are personal