Highlights of the monetary policy
- In a move that surprised markets, the MPC opted to keep the repo rates static at 5.15%.
- That retains reverse repo rate at 4.90% and the MSF and Bank rate at 5.40%.
- The MPC decided to continue its “Accommodative” stance subject to inflation caveat.
- MPC included inflation as a key factor this policy, rather than focus only on growth.
- All six members voted for status quo on repo rates.
It must be said that the markets are likely to be surprised by the decision to not cut rates in the December policy. Not only the bond markets (as represented by the 10-year benchmark yields) but also the rupee/dollar market was hinting at a rate cut with the INR weakening versus the dollar.
Twin challenges of inflation and real rates
If one were to summarize the theme of the December policy, the MPC has shown caution on the rates front largely due to concerns over inflation and real rates. Let us look at inflation first. The CPI inflation for October touched a level of 4.6%, which is well above the RBI comfort zone of 4% average. The key driver of higher inflation in the last couple of months has been food. In fact, food inflation in October had touched a 39-month high of 6.9%. Despite a reasonable Kharif harvest, there was extensive crop damage due to unseasonal rains post September. RBI does not expect food inflation to moderate soon. If OPEC opts to hike supply cuts to 1.6 million bpd then even fuel inflation may come under pressure.
The second key aspect is real interest rates (interest rates net of inflation). Till 2018, real rates in India were in the region of around 4%, which made Indian debt very attractive to global investors. Since the beginning of 2019, rates are down by 135 bps and inflation up by 200 bps. This has substantially narrowed the real interest rates. For example, the repo rate at 5.15% and CPI inflation at 4.60% leaves a real rate of just about 55 bps. That is not a very attractive level for foreign portfolio flows into debt. That is reason why FPI flows into debt were negative in Nov-19. The government will need to hold the real rates at attractive levels to ensure that FPI flows into debt continue.
Monetary transmission – more data points needed
Another reason why the RBI chose to go slow on rate cuts is the need to observe effective transmission. In fact, that has been one of the problems that the RBI had with banks. Since the beginning of 2019, RBI had cut rates by 135 bps. This has transmitted in the form of lower rates on corporate debt and money markets at above 100%. In the case of the G-Sec market, the transmission has been close to 90 bps, which is still a good number. The real laggard has been bank lending where the median MCLR has fallen by just 44 bps. However, transmission has been rapid since banks moved to the external benchmarking model in October 2019. Considering that RBI has kept its stance as accommodative, it may look to cut rates further once there is greater traction on the transmission front.
Additional measures by RBI
Outside of rates and liquidity, the RBI has also made some other important announcements.
- RBI has suggested regulatory guidelines for reducing the concentration risk in urban cooperative banks, especially in the light of the PMC Bank issue. They will also integrate into the central credits repository.
- RBI will set up a self regulatory body (SRO) for development of secondary market for loans. The SRO will standardize practices, documents and covenants.
- RBI, as promised, has placed the guidelines for on-tap licensing of small finance banks for public comments and will be taken up shortly.
- In tune with demand of P2P lenders and the P2P platforms, the RBI has increased the total exposure across all borrowers for a single lender from Rs.10 lakhs to Rs.50 lakhs.
- Residents and NRIs can take up OTC foreign currency position up to $10 million without evidencing any underlying exposure.
The RBI has played its cards cautiously. It has preferred to keep real rates positive and observe inflation and transmission. With the monetary stance still accommodative, all eyes will be on the next policy on Feb 06, 2020.