BackMarkets looking beyond Raghuram Rajan, August policy
The next rate cut may happen as early as in October if inflation starts slowing and the monsoon ends on a good note; and, of course, much will depend on who succeeds Rajan
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The markets seem to be quite happy with the move by the Reserve Bank of India (RBI) to put licences for universal banks on tap—probably a parting gift from outgoing governor Raghuram Rajan.
The chances of Rajan gifting a rate cut on Tuesday, in the last bimonthly monetary policy review before his term ends in the first week of September, are bleak, but bankers wouldn’t be complaining. A rate cut may come later this year—and could be as early as in October, in the next monetary policy announcement.
The markets, at this point, are looking beyond Rajan and the August policy, even as government bond yields have been going down, helping banks notch up handsome gains in treasury operations.
Until now, bank licensing has been a once-in-a-decade affair. Now, the window will remain open and domestic entities and experienced banking professionals can move the regulator for a bank licence any time they wish to, the way foreign banks have been doing. India had freed the interest rates both for borrowing and deposits, but financial repression continued because of a restrictive licensing policy.
The on-tap licensing system will change the scenario, intensify competition and force banks to be more efficient and innovative in meeting customers’ needs.
During Rajan’s tenure, RBI has given licences to two universal banks (both are up and running), 10 small finance banks (one of them has started operations) and 11 payments banks (three of them have surrendered their licences). The banking regulator has also proposed to offer licences to differentiated banks such as wholesale banks and custodian banks, to make the sector more diverse.
On the monetary policy front, everyone will be watching for whether the governor reiterates the accommodative policy stance he had emphasized in the June policy, when, after paring the policy rate by 150 basis points between January 2015 and April 2016, Rajan pressed the pause button amid inflation concerns. (A basis point is one-hundredth of a percentage point.)
What has changed since the June policy was presented?
Well, liquidity in the banking system has improved substantially. In fact, for several days in the past fortnight, the banking system had excess liquidity; many banks have been parking money with RBI instead of borrowing from the central bank. In technical terms, they are not knocking at RBI’s repurchase or repo window from where they can borrow money, offering government securities as collateral. Instead, they are keeping their excess money at RBI’s reverse repo window.
This followed a shift in RBI’s stance on liquidity management in the first bimonthly policy for fiscal year 2017 in April—from a banking system with a 1% deficit of the so-called net demand and time liabilities, or NDTL, (loosely, a proxy for deposits) to a position “closer to neutrality". Even though the stated position had been to keep the system in a 1% deficit mode, in reality, the deficit had been much higher—about 1.5% of NDTL. The average daily net liquidity injection by RBI into the Indian banking system has progressively been coming down since then, and now, on certain days, the system has surplus money.
Also, the April policy narrowed the so-called interest rate corridor between the repo rate (the rate at which banks borrow from RBI) and the reverse repo rate (the rate at which banks park their excess money with RBI) from 1% to 0.5%. This means, banks now borrow from RBI at 6.5% and keep excess money with the central bank at 6%.
The other significant development is that, after the UK’s decision to withdraw from the European Union through a referendum on 23 June, globally there has been a sharp rally in bond prices, pushing their yields down. The yield on 10-year government paper, during this time, has dropped from around 7.45/50% to 7.15/20%, a three-year low.
These two factors are expected to make the tone of the policy document less hawkish than it otherwise would have been, but nobody is expecting a rate cut because inflation pressure has not eased as yet.
Wholesale price inflation rose to a 20-month high at 1.62% year-on-year in June, rising for the fifth successive month. It had turned positive in April after remaining negative for 18 months. More importantly, inflation measured by the consumer price index (CPI) rose marginally to 5.77% in June, a 21-month high, from 5.76% in May on the back of higher food prices. It could rise further and cross 6% in July before coming down in August because of a favourable base effect.
Most analysts feel that RBI’s 5% retail inflation target in January 2017 could be breached, in sync with the regulator’s “upside bias". However, if the monsoon remains on track and global commodity prices do not harden much, the rise beyond 5% is unlikely to be too much.
Industrial production grew by 1.2% in May after seeing a contraction in the previous month, mainly due a to rise in consumer durables output. Cumulatively, factory output in April-May contracted by 0.1% compared with a 2.8% expansion in the same period a year earlier, but this is unlikely to cut any ice with the governor when he takes a call on the policy rate.
In fact, if Rajan’s response to a query whether RBI has been behind the curve on cutting its policy rate in an interaction with the media last month is any indication, he has ruled out a rate cut. “This discussion keeps going on without any economic basis... 5.8% is the CPI inflation (in June), our policy rate it 6.5%... I don’t really pay attention to this kind of dialogue," he said.
However, most analysts expect at least one 25 basis-point rate cut—and some of them even two—by the end of the fiscal year in March 2017, even as the possibility of another rate hike by the US Federal Reserve during the calendar year is receding and there are no visible signs of any uptrend in the economic scenario in Europe and Japan.
Last week, the Bank of England also cut its policy rate—for the first time since 2009—to a historic low of 0.25%, and announced a new stimulus package to boost sagging economic growth. Indeed, commodity prices are not as soft as they were early this year, but the price of crude oil has started coming down again in the past few weeks.
Many believe that the next rate cut can happen as early as in October if inflation starts going down in August and the monsoon ends on a good note. And, of course, much will depend on who succeeds Rajan as RBI governor.
There are, of course, risks to this prognosis. One of them is the impact of the implementation of the Seventh Pay Commission’s recommendations. Close to 10 million employees and pensioners will see a rise in their incomes in August. The government has deferred one component of their salary—the housing rent allowance (HRA). A committee is now looking into this and its recommendations are expected in the next few months. HRA is a key contributor to retail inflation.
One also needs to see how banks absorb the impact of close to $26 billion in redemption of foreign currency non-resident (FCNR) deposits beginning in September. Indian banks raised this money overseas to support the rupee in September 2013 and swapped it with the central bank. This means the banks raised dollar deposits and sold them to RBI for rupees; now they would return the money to the central bank and get back the dollars to redeem the deposits at maturity.
Indeed RBI is fully prepared for the redemption; it has hedged its position in the forwards market and we have $363 billion in foreign exchange reserves. Some investors may even roll over the deposits. Clarity will emerge on this by the time RBI gets ready for its October policy.
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
Comments are welcome at bankerstrust@livemint.com
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