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Room For A Rate Cut?

Monday, September 29, 2014
By Dominic Rebello

India’s economic report card for “H1-FY15 appears to be more robust than it did over corresponding, in the previous fiscal. With a 5.7% GDP growth in
Q1-FY15 (4.7% in Q1 FY14) and significantly lower inflation along with a healthier external account balance, the fundamentals paint a good picture of the economy, albeit relatively” says Care Ratings. However, there has been a slow credit pick up in FY15 vis-à-vis FY14 levels and industrial production has not accelerated consistently as would have been desired. Against this background, the RBI is due to announce its bi-monthly credit policy tomorrow.

Will RBI  change its policy stance given that CPI inflation has to be contained at 8% by January ’15 which in the festive season and expected pick-up in consumer demand would be tricky to attain if interest rates were to be lowered?  Is there any room for a rate cut? Tomorrow will tell...

In the meanwhile in a just released report, Care Ratings brings out  the expectations from the ensuing credit policy announcement and subsequently lays out an interest rate outlook for the ongoing fiscal in view of certain key parameters.

10-yr G-Sec and Government Borrowing
The 10 year Government Security so far this year has been moving downwards. It has fallen to be around 8.49% from its 8.8% – 8.9% level at the start of the fiscal. The new 8.40% paper was introduced in the end of July ’14 following which yields have remained particularly lower.

Government has envisaged a total of Rs 6 lakh Crore borrowings in FY15, of which Rs 3.68 lakh Crore was to be borrowed in H1-FY15. However, the actual borrowings stand lower at Rs 3.38 lakh Crore. Liquidity position thus appears to be comfortable as the Government is to repurchase a total of securities worth Rs 20,000 Crore indicating there is in fact excess liquidity.

Overtly, it appears as if the Government will potentially indulge in lower market borrowings than the initially estimated Rs 6 lakh Crore in the Budget for FY15. This will ofcourse depend on the inflow of taxes especially those linked to industrial production and imports.

Inflation threat
Inflation at the wholesale and retail level has moderated from the levels at the start of the current fiscal. However, inflation has admittedly been tamed to a large extent due to a high base effect as well as the markedly lower fuel prices globally in recent months compared with months earlier in FY15. While there has been reduction in inflation measures (WPI and CPI), the current level of CPI inflation is still high.

The RBI is looking to rein in CPI inflation to a target of 8% by January ‘15 and with CPI still at 7.8% as of August ‘14, inflation worries are not alleviated yet.

Further, there remain certain upward threats to inflation going ahead:  Firstly, it remains to be seen how the subnormal and delayed monsoon this year influences crop produce this harvest season, the effect of which will be seen in the agricultural products prices in Q3 and Q4 FY15. The Ministry of Agriculture has indicated that production of coarse cereals, pulses, oilseeds, sugarcane would be lower than that last year.  Secondly, currently there is a supply glut in the oil market; any untoward geo-political development in the OPEC region can trigger a price rise, which will have a strong bearing on domestic oil prices and overall inflation basket.

Liquidity management
Since the recommendation of the Dr. Urjit Patel Committee in December ’13, RBI has gradually shifted to managing liquidity through term repo auctions. This was with a view to better the transmission mechanism of the monetary policy as also to adequately manage the flow of liquidity across the spectrum.
Currently there appears to be less pressure on liquidity in the banking system as the aggregate deposits across banks stands at Rs 81,32,710 Crore as of 24th September 2014, while the amount outstanding through the various repo borrowings stands at Rs 68,305 Crore. Given the 1% of NDTL exposure for LAF, there is a sufficient window upto an additional Rs 13,022 Crore approximately to further make available for repo borrowings.

Credit, deposit and investment
H1-FY15 has been characterized with low credit growth relative to deposit growth. As of 5th September 2014, credit growth stood at 2.4% as against 6.4% over the corresponding period in the previous fiscal. Deposit growth is comparatively higher at 5.9% as of 5th September 2014 compared with 5.5% over the corresponding period in FY14. Credit off take has remained low. However there are expectations that this might reverse as the festive season nears.

CARE Ratings View
Given the above economic parameters of improving growth of 5.7% (Q1 FY15) GDP and elevated retail inflation on the back of potential threats to inflation going ahead, we do not foresee any room for a rate cut in the upcoming policy announcement. On the other hand, we expect RBI to maintain the repo rate at 8%.

It looks unlikely that RBI will change its policy stance given that CPI inflation has to be contained at 8% by January ’15 which in the festive season and expected pick-up in consumer demand would be tricky to attain if interest rates were to be lowered.

A cut in SLR could be there more to ease LAF access to banks at the margin, as the system still has surplus SLR securities.

On the Interest rate front, The 10 year Government security is expected to remain within the 8.4% - 8.6% range. Further, as an external factor any rate hike by the Fed in 2015 can cause it to move upwards. Further, a pick-up in credit relative to deposit growth in the second half of the ongoing fiscal and during the festive season may push interest rates upwards. A downward movement would be possible once the RBI cuts the repo rate.

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