We expect an additional and front-loaded 50 bps of repo rate cuts during CY2015: Shubhada Rao

Q&A with Senior President & Chief Economist, YES Bank

Shubhada M Rao, Senior President & Chief Economist in an interview with Tulemino Antao shares her views after the RBI maintained status quo on key rates at its policy review today. Edited excerpts:

What is your take on the Reserve Bank of India's move to keep key rates unchanged at its policy meet today?

After the surprise rate cut in January, maintenance of status quo on monetary policy was widely anticipated by the markets.  Lack of new incremental information on inflation and fiscal outlook, two important decision making variables, necessitated a continuation of the existing monetary policy stance. In its bid to support growth, RBI has commissioned a 50 bps cut in SLR, which will enhance potential liquidity to banks that can be used to increase lending to productive sectors of the economy. Further, projects which have been stalled because of change in ownership can now get an extension of the DCCO (date of commencement of commercial operations), without adversely affecting the asset classification of such loans. Additionally, the extension of the dispensation to NPAs with respect to reversing the excess provision on sale of NPAs to securitization/reconstruction companies, should help to expedite implementation of delayed projects and help banks recover appropriate value from their NPAs respectively.

Is the RBI's inflation target of 6% by January 2016 and a risk-free policy rate of 1.5-2% achievable?

We expect CPI inflation to undershoot RBI’s Jan-16 target of 6% by ~20 bps on account of salubrious impact of seasonal decline in food inflation, fall in global commodity prices and restrained pricing power amid moderating rural wage growth and households’ inflation expectations. Given the favourable inflation path, we expect an additional and front-loaded 50 bps of repo rate cuts during CY2015, making real policy rate of 1.5-2% a comfortably achievable target. The risk-free rate is a step ahead from this, accounting for the risk aspect as well, and which we would say the RBI intends to view in the longer-term.

Generally there is lag of a few quarters for transmission of policy to call money rates. How have been the trends on call money rates since the rate cut in mid-January and by which quarter of the next fiscal do you see the full impact?

There are mainly four transmission channels of monetary policy- interest rates, asset prices, exchange rate and expectations. Call money rates or short-term rates form just a part of the overall story and have already corrected by around 33bps (on average) since the rate cut in mid-January. Active liquidity management under the new framework adopted in September and the expectations of further monetary easing have also played an important role in bringing down the call rates (December-14: 8.03% and CYTD 2015: 7.66%). The lag under the interest rate channel is more with respect to the real long-term interest rate which ultimately is more important and influences business investment or durable consumption decisions. As per our analysis, this effect takes around two to three quarters after the change in policy rate.

Global crude prices seem to have bottomed after they rebounded sharply to around $55 a barrel. Due you see the benefits of lower crude oil prices on inflation waning a bit?

Crude oil prices have fallen close to 60 percent since their 2014 peak, and a this has showed up to a fair extent in WPI (which directly incorporates several components of fuel, having a weight of 15%) and CPI (in which fuel impact seeps in partly through the CPI fuel component and partly through the CPI services’ component of transport). Based on the incoming readings of both inflation prints, we would say that the impact of large crude price decline has not translated fully as yet, and will continue to show up going forward. Moreover, analysts project the oil slump to continue into the next year as well, so inflation prints may not move sharply, ceterus paribus. The significantly lower crude prices will seep into other components of inflation as well. We would view the sharp increase in crude oil starting last week as a risk, and not our base case, until sharper and prolonged and lasting a considerable period of time. Oil remains much below its USD 100/bbl normal for now.

What is your view on the central bank's strategy to keep the rupee from appreciating further and has raised foreign investment limit to $250,000?

On back of lower oil import bill and higher foreign fund inflows, country’s foreign exchange reserve touched an all time high of USD 322bn in January-2015. This has given RBI the room to approach, intervene and tackle the likely risk of sustained rupee overvaluation. In our view, taking into account the productivity and inflation differential of India, with respect to other nations, rupee at current levels is not considerably overvalued. However, given India’s outrun in the EMs space and compelling QE operations from the ECB and BOJ, there is a risk that rupee appreciation could impact export competitiveness. With such a backdrop, increase in investment limit is pre-emptive and a proficient step.

With the upcoming Budget in mind do you think the central bank's policy to keep rates unchanged impact economic growth?

The Central Bank has maintained a stance that it wants GDP growth at a long-term sustainable level, while also keeping inflation in due check. It cut interest rates in mid-January when it felt that inflation pressures may have cooled to some extent and investment pickup may be required. RBI also needs to keep a watch on the quality and quantity of the fiscal deficit as an expanding fiscal deficit puts a stoke in the wheel of declining inflation, while providing short-term spurts to growth via the multiplier effect. Given this, the RBI has decided to stay on hold in this policy. It wants to view the budget numbers before it can go ahead with rate cuts, reassured that the fiscal will not sway the economy from its goals.

Corporate India which was expecting a rate cut seems to be unhappy with RBI's stance to keep rates unchanged. What trends do you see for corporate loan growth in the next fiscal?

Corporate India has been bullish on India rate cycle. The RBI on the other hand, has maintained that the  monetary easing would be data driven, which was reflected in the off-cycle move in mid-January. With no incremental data in the offing, RBI decided to stay put. On loan growth, we believe that the progress in credit is more a function of demand in the economy, which is gradually picking up. In anticipation of this, RBI has reduced SLR to 21.50% from 22.50%. This reduction will provide approximately INR 450 bn of potential liquidity to banks, which can be used to increase lending to productive sectors of the economy. Overall, for FY16, we are penciling in a growth in bank credit to the tune of 14.50%. The immediate triggers are going to be coal  blocks and spectrum auction while a sustained recovery momentum in the economy will remain the key.