BackStatus quo expected: have interest rates plateaued?
RBI will want to wait to see whether the increase in inflation is transitory before it chooses to use any available room to cut rates further
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The Reserve Bank of India (RBI) will head into its second monetary policy review of the current fiscal on Tuesday. In comparison to the big bang April policy, where the central bank decided to ease liquidity conditions substantially to improve transmission of lower rates, the June policy is expected to be a quiet one.
A status quo in June won’t surprise anyone though. As such, the more relevant question to seek an answer to is whether interest rates, more broadly, have plateaued?
To begin with, there is no compelling reason to move the headline policy rate (repo rate) lower at this stage. The last print on Consumer Price Index (CPI) inflation for April came in on the higher side at 5.4%. While core inflation was steady, food and transportation costs rose. The rise in food prices also put an end to the 18-month long streak of deflation in the Wholesale Price Index (WPI). Apart from higher food prices, WPI data had also shown an uptick in manufactured products inflation.
RBI will want to wait to see whether the increase in inflation is transitory before it chooses to use any available room to cut rates further. Not everyone believes that the uptick in inflation is fleeting. Rajeev Malik, a senior economist at CLSA, in an editorial in Mint on 31 May, argued that there is too much complacency on the inflation front and even highlighted the possible upside risks to inflation that may emerge from the higher food prices, the impact of a rebound in oil prices and consumption-driven demand that the pay commission payouts will generate (https://bit.ly/1RQ5hkW ).
Still, the median view suggests that RBI will cut rates by another 25 basis points (bps) this calendar year. (One basis point is one-hundredth of a percentage point.) HSBC believes the cut will come in August. Kotak Research expects RBI to weigh global risks and the uptick in crude prices before it settles on a timeframe for the next cut.
It would be fair to believe that the policy rate have more or less hit a floor for now.
What about bank lending rates? At the time of the April policy, when RBI abandoned its stance of maintaining a liquidity deficit and said it would move towards neutral liquidity over the period of a year, the expectation was that this comfort on liquidity will allow banks to lower their lending rates. There have been some easing of rates since the April policy but it has not been substantial. For instance, Axis Bank Ltd pegged down its marginal cost of funds-based lending rate (MCLR) in April by 15 bps. State Bank of India reduced their new benchmark rates by 5 bps in May, and ICICI Bank Ltd announced a similar cut on Wednesday. But there has been no noticeable move lower on rates—deposit or lending.
Even in the bond markets, rates have actually risen rather than fallen. The 10-year benchmark yield has risen 7 bps to 7.48% from 7.41%, the 91-day treasury-bill rates are steady at 6.8%, and the three-month commercial paper rates are up about 9 bps at 7.96% compared to 7.87% at the time of the April policy.
Does this mean that RBI’s liquidity policy is not working? No. It means that the impact of the policy will flow through over time but may not be as dramatic as earlier expected.
In a note on 3 May, Sajjid Chinoy, chief India economist at JP Morgan India, stated that the early reaction to the policy shift has been muted possibly reflecting the uncertainty around how quickly the liquidity deficit would be bridged and the impact of the policy on market interest rates. Chinoy, in his research note, assessed the expected steady state impact of the policy on market rates and concluded that the new liquidity framework will move the yield curve lower by about 25 bps.
“It is important to underscore, however, that these are all steady state impacts; when the market begins to price these in would depend upon expectations of how quickly the RBI can reduce the system deficit and whether the anticipated quantum of OMOs (open-market operations) is materialising," said Chinoy.
As such, the RBI’s liquidity policy is still work in progress and it may not want to change its policy rate and policy stance until the new framework is fully implemented. In the absence of any rate driven headlines, the focus on the monetary policy day may shift towards any guidance that RBI gives and whether they see the window for rate cuts closing.
Ira Dugal, deputy managing editor, Mint.
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