Quantum View : Repo Rate Below 6%; first time since 2010

The Monetary Policy Committee (MPC) of the Reserve Bank of India delivered its third consecutive 25 bps rate cut but the first unanimous decision in this rate cutting cycle. It has of course also coincided with the change in the RBI Governor with Shaktikanta Das voting for the rate cut in all 3 meetings.

The MPC having voted 4-2 in the February and April policy meetings when they reduced the Repo rate from 6.5% back to 6.0%; voted 6-0 in the June policy meeting to take the Repo Rate to 5.75%.

This holds significance as the Repo Rate has breached below the 6% rate for the first time since 2010. That tells you that India has struggled to get low interest rates over many years now. As many regular readers of Quantum View would know our stated view that In the 4% CPI Inflation Target plus 1-2% Real Rate Framework, we do not expect the Repo Rate to go and sustain below the 6% range

So this rate move below the 6.0% level and one that was secured with an unanimous vote is particularly noteworthy.

What is of even more significance is the change in stance to accommodative. The RBIs response to the question on accommodative stance leaned more towards the direction of ‘with the move to accommodative stance, rate hikes are out of the table’.

The markets should of course read it as a clear indication that the RBI is deeply concerned about growth and is prepared to use interest rates and liquidity to boost demand.

We expect another 25 bps rate cut in August but will caution against too much exuberance on rate cuts post that.

That the Repo rate has been cut below 6% and the stance has changed to accommodative has happened only twice in the last 20 years; Once post the Lehman crisis, 2008-2009 and the other post the dot com, global slowdown in 2002-2003 period. As we noted above, it is not a common occurrence in India. We should also note that growth levels and prospects was way lower during those times to justify Repo rates well below 6%.

In 2008-09, they were fighting a global financial crisis and responded to it by cutting rates sharply and adding in huge amounts of liquidity. We do now know in hindsight that delayed rate hikes by the RBI then did end up complicating the macro-economic and fiscal issues.

In 2002-03, India was running a current account deficit on the back of global slowdown, the NDA government was successful in keeping inflation low despite drought and at the same time attract capital inflows. RBI responded to support growth as well as to dampen capital inflows and keep INR under check.

The MPC, this time, although worried on growth, has still retained the GDP forecast at around 7%. At above the 7.5% GDP growth (in the new series) is where the RBI believes is the potential level of output growth. So if they believe the 7% GDP target for FY 20 to be true, there isn’t much panic and need to cut rates aggressively to push up growth to potential.

GDP growth has of course been on a downslide for a few quarters and we believe a major reason to be due to liquidity not being to the sufficient level in the economy. The Currency to GDP ratio has remained below its long term average since demonetization and we wonder whether India has indeed had trouble in adjusting to the lower cash in the system. We very commonly hear the Mumbai business trader lamenting ‘market mein paisa nahin hein’; the real estate market is also stuck in low sales resulting in cash being stuck in assets not liquidating.

The RBI has added considerable liquidity into the system especially in the last 6 months and we expect that currency which went out of the system pre elections should come back in the next two months. By August when RBI declares its dividend, system liquidity should be in a comfortable surplus aiding monetary transmission. The RBI thus seems relatively confident of GDP growth inching higher towards 7.5% in H2 Fy 20. They have also quite clearly stayed away from explicitly announcing any liquidity support for NBFCs which seeme to have left the Equity Markets disappointed.

For the bond markets though the policy outcome had lot of good things. Bond yields may have further room to drop as the markets will execpt further rate cuts especially another 25 bps in August to take the Repo rate to 5.5%.

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