Posted On Tuesday, Aug 04, 2015
As expected, the RBI left the key rates unchanged. So the Repo rate remains at 7.25%. Given that they had 'front-loaded' a 25 bps cut in the June policy; markets were not really expecting a rate cut today.
Markets move on expectations and thus it was important to ascertain if there are more rate cuts coming ahead. We found the statement more accommodative as they find inflation risks balanced which suggests that one should expect rate cuts ahead and it is only a matter of timing.
Post the June cut, we had moved our next cut timing to Q1 2016 - post a satisfactory achievement of the 6% January 2016 target.
Given recent developments; we are inclined to bring it forward and will not rule out a chance of a 25bps cut in the September 29th policy review itself.
• Recent drop in oil prices are extremely encouraging for India inflation and twin deficit outlook
• Spatial monsoon patterns are better than the headline monsoon deficit numbers which is showing up in better crop sowing data.
• The government has hiked food support (MSP) prices by less than 5% which should keep rural incomes/ wages low and potential food inflation below 5%
• Global commodity prices are at decade lows and in that given the stronger INR should have further dis-inflationary but lagged impact on CPI inflation
• Indian asset markets handled the Greek crisis quite well and thus the confidence on managing Fed induced volatility should be higher
We would still assume the FED action will have the most bearing on RBIs rate outlook. Although markets seem to have pushed the FED lift-off to December; we expect FED to move in September or atleast provide greater clarity on its trajectory. If India handles the FED induced volatility well, it would increase global investors’ confidence and also allow RBI greater comfort in increasing Foreigners bond investment limits.
We liked what we heard from the governor on FPI bond investment limit framework. As has been our demand since long; we expect the limit increase to be linked to either outstanding issuance or as a % of annual fiscal deficit. The limits will be reviewed every six months and will be denominated in INR and thus will take out the USD/INR movement impact.
The framework will get announced but the actual limit increase is also we think tied to the FED action. So one should expect a USD 10 bln increase in bond limits for foreigners post the FED September meeting outcome.
As has been highlighted in our earlier report; this limit increase is required to clear the bond market and balance the demand/supply. Until then, term spreads on offer @ 50bps + will continue to remain attractive.
As long term investors, we will continue to remain invested with a marked bias towards government bonds and with a higher than average duration and wait for spread compression on limit increase and for the markets to start pricing in the September rate cut for an eventual move down in yields.
The INR although weaker YTD; but is still broadly in our band of INR 62-65 which we laid down in December 2014. And has continued to hold up well on a relative basis despite a very strong Dollar. We maintain the band for the rest of the year.
FSLRC / Monetary policy committee
The recommendations of the FSLRC (Financial Sector legislative Reforms commission), a committee setup in 2010 to review and re-write India's financial sector regulatory architecture, continues to attract immense press; academic and investor scrutiny.
Although there is much to like about the FSLRC report; but there is one design there which is of utmost concern (at least to us at Quantum).
It Is the agenda to take away powers from the RBI. It is as if whatever is wrong in the country is due to the RBI.
RBI may be bureaucratic but we believe that it is among the few credible institutions left in the country and needs to remain so.
In the last few days, a section of the revised report of the committee put up on the website for comments has invited tremendous scrutiny by the press. The recommendation on 'giving more powers to the government in the formation of a Monetary policy committee and taking away the 'RBI governor's veto power in deciding interest rates’ is being seen as an attack on RBI's independence.
Governor Rajan, in the post policy press conference provided some clarity and we read it as 'the RBI not being opposed to the idea of the RBI governor not having veto power'. And the fact that 'de-facto' independence is more important than 'de-jure' independence.
We believe the report and its recommendation, specifically on the powers of the RBI, has long term policy repercussions and needs to be very carefully dealt with. Investors, over the years have accorded more trust and faith on the actions of the Reserve bank than of the government.
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