RBI MPC Meet: Indian economy perspective and the road ahead

For the third successive time from February to June 2019, the monetary policy committee (MPC) of the Reserve Bank of India cut the benchmark repo rate by 25 basis points bringing the repo rate down to 5.75% from 6.50% at the start of the year. The Apex Bank also changed the stance of monetary policy too accommodative from neutral, which means the market can expect rate cut anytime. The RBI acknowledged the sharp deceleration in growth & the beginning inflationary environment in recent months, which has given room for the rate reduction. 

Speaking on the trigger for the markets and the national economy and RBI's role in the days ahead Saurav Goyal, Head of Finance, Money View said, "The next major domestic trigger is going to be the Union Budget in early July. Given the large undershoots in the actual revenue collections in FY 19 versus even the revised numbers presented in February, the numbers targeted in the interim budget are looking truly challenging. The new finance minister will have a task to present a credible budget while sticking to the assumed deficit target. In this context, the Jalan committee's report on potential excess RBI reserves and their usage by the government will assume importance." 

One aspect that is often forgotten in the monetary policy debates is that the direct impact of interest rate changes is only on the rate of interest paid by banks to each other in the overnight market. The rates of interest on customer transactions such as the fixed deposit rate or the lending rate (marginal cost based lending rate, MCLR) are only indirectly affected through the provision of liquidity by the RBI. 

On liquidity address by the Apex Bank, Saurav Goyal of Money View said, "In fact for several parts of the curve yields have risen in recent months with the stance of monetary policy. This has been due to current liquidity conditions in the financial sector. Post-IL&FS crisis, NBFC liquidity stress is well known and widely reported, but banks too have been facing their own version of liquidity. This can be seen by looking at the relative growth rates of bank loans versus deposits where for the past two years credit growth has been outpacing deposit growth rates. In fact, the absolute increase in bank credit during the last financial year was about 99% of the absolute increase in deposits. Normally this ratio is in the range of 75-80% as a part of the deposits need to be set aside in the form of SLR, CRR and LCR. A ratio of 99% suggests that banks have not added any amount to these liquidity buffers during the past year. For the financial year 2017-18, that ratio was 112% implying that banks were dipping into their stock of SLR/CRR/LCR to make loans. Thus liquidity has been drained from the system." 

Saurav Goyal of Money View went on to add that the implication is that if the RBI intended for lower rates to stimulate the economy, it is not working. Last financial year RBI infused nearly 3 trillion of liquidity through open market operations – the highest amount ever. But in the previous year, it drained about 1 tr. from the system. Over the two year period then the RBI only infused about 2 tr. against a liquidity requirement of about 5 tr. (average annual requirement of 2.5 tr.) A rethinking is required in terms of liquidity infusion if lower rates are to be transmitted to the real economy. 

"To that end, the RBI has decided to constitute a working group to review the liquidity management framework. Similarly, the money market plays a key role in transmitting rates to the broader economy. Here too the RBI has decided to review its various directions and create a comprehensive framework for the money markets," said Saurav Goyal of Money View.

The bond markets have cheered the policy decision with the 10-year yield dropping by about 10 bps to 6.90%. Thanks to the tight liquidity environment, short rates have remained elevated for some time and continue to offer good value, though the curve has steepened over the course of the last month and longer-term bonds to appear to have some value now.