RBI Cuts Interest Rates Again, Repo Rate at 7.25%

Posted On Wednesday, Jun 03, 2015


The Reserve Bank of India (RBI) governor Raghuram Rajan cut interest rates for a third time this year on Tuesday, 2nd June, 2015 taking advantage of subdued inflation to give more support to an economy. Mr. Rajan’s move widely disappointed markets which fell by 660.6 points to close at a three week low of 27,188, as many market players were hoping for a 50bps cut.

However, as we expected the RBI cut the Repo rate by 25 bps to lower it to 7.25%. This means that the RBI has cut interest rates by 75 bps since Jan 2015. Repo rate, the rate at which RBI lends to commercial banks in the event of any shortfall of funds, is the tool used by RBI to manage inflation in the economy.

With this rate cut; Governor Rajan is back where he began. In September 2013; when he took over as the governor of RBI; the Repo rate was at 7.25%. He hiked the repo rate to 8% by February 2014 to signal the RBIs inflation fighting credentials and its move to a CPI inflation targeting driven monetary policy framework. As CPI inflation fell more than anticipated in the last year he has front-loaded the rate cuts to bring the Repo rate back to 7.25%.

This is exactly as we anticipated and as we had laid down the provisos for further rate cuts; we believe the RBI is likely to go on a long pause till at least the first quarter of 2016, read not more rate cuts.

“First, some forecasters, notably the IMD, predict a below-normal southwest monsoon. Astute food management is needed to mitigate possible inflationary effects. Second, crude prices have been firming amidst considerable volatility, and geo-political risks are ever present. Third, volatility in the external environment could impact inflation. Therefore, a conservative strategy would be to wait, especially for more certainty on both the monsoon outturn as well as the effects of government responses if it turns out to be weak.”

Decoding the above statement by the RBI - unless there is a positive monsoon outlook and deft food management by the government, we believe the RBI is likely to wait till it is sure of achieving the 6% January 2016 CPI target. So, if then CPI pegs around 5.5%; there would be scope for more cuts. But that is likelihood for later and there is no immediate impetus for it.

Markets have clearly not liked the outlook. So despite a rate cut; given that further easing appears limited; both the Equity and Bond markets sold off yesterday.

Bond markets have a supply-demand issue. Last year, foreigners and domestic mutual funds were big buyers which absorbed the supply. In the absence of fresh limits for foreigners and muted inflows into domestic bond funds; the markets have a challenge in absorbing the supply.

So till the time the government bond limits for foreigners are increased; we expect the term spreads to remain attractive.

The RBI has shifted its growth and inflation targets. The RBI now expects inflation to be around 6% due to the expectation of a poor monsoon; up from its forecast last time of 5.8%. At the same time it has revised the GDP growth downwards as the government report showed that the growth for FY 15 was lower than initially expected.

It is difficult to have a precise estimate of the new GDP series; but the break-up of GVA (Gross Value added) suggests investment and manufacturing activity has slowed in the last 2 quarters. With the poor monsoon outlook; downward revisions are possible.

The new 10 year bond is trading at 7.7%; whereas much of the older curve is trading in around the 7.85%-8.0% range. With the lending rate at 7.25%, and investors getting returns of about 8% in 5 year bonds, these bonds seem to be attractively priced.

As pointed out by the Governor, it is common for banks to promptly lower their deposit rates and keep lending rates unchanged for long. This time, following RBI’s rate cut few banks have already cut EMI for loans. Deposits rates would come down too. However with the next rate cut far away, EMIs may stay there for a while after the present rate cut benefit is passed on.

All said and done, for you as an end-investor, RBI's decision on monetary policy can be considered as a direction for the macroeconomic scene, rather than treating it as an information to base investing decisions on. Stay invested in the different asset classes, based on your financial goals.

Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.

Above article is authored by Quantum.

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