[Investors Please Listen] RBI Watch - preserving last arrows of its arsenal

RBI may follow status quo

The Reserve Bank of India (RBI) will announce Annual Policy Statement for FY10 tomorrow, April 21. Apart from measures regarding repo, reverse repo rates and cash reserve ratio (CRR), the policy will highlight the central bank's assumptions on GDP growth rate, inflation, money supply and bank credit growth rate during FY10.

 

With regards to policy rates, we believe that the likelihood of continued slowdown in the real economy may induce RBI to cut repo and reverse repo rates by up to 50bps each over the next three months. In our view, the central bank is however close to the end of its rate cut cycle, and will preserve the last spell of the rate cut for a more appropriate time. At the moment, a large chunk of the reduction in policy rates (repo and reverse repo) has not been transmitted onwards by banks. Thus, we believe, RBI will try to induce banks to reduce their lending rates, but will not reduce the policy rates further in the current round of the policy. Moreover, the transmission lag of monetary policy in India is long and is often believed to have an impact on the real economy even after four-six quarters. Given the possibility of inflation resurfacing in CY10, a conservative central bank has reasons to go slow on cutting interest rates at this juncture.

 

The consumer price index (CPI)-based inflation is still high, well over 9% Y-o-Y at end-February. Reflecting the higher weightage of food-related commodities, CPI is relatively less impacted by a rate action of the central bank. Still, the high CPI inflation can act as an additional speed-breaker for further rate cut by RBI at this moment.

 

The prevalence of huge liquidity (reverse repo balance over INR 1,000 bn) will ensure no further reduction in CRR at the moment.

 

Quantitave measures to augment credit flow

At this moment, RBI may take quantitative measures rather than rate action, to be more effective in keeping interest rates low and to induce banks to disburse more credit. It may once more spell out its intention to support the bond market with continued and large open market operations (OMO).

 

Another option with RBI is to put a cap on the quantum of reverse repo. It had attempted such a move earlier in 2007, but had withdrawn it within only five months as call rates fell to near zero. The central bank may still attempt this once again this time since there is a severe need to push funds out of the idle parking lot of reverse repo and to move the same to credit. In 2007, RBI had tried the same with a cap of only INR 30 bn; this time, the limit could be raised to ~INR 200-250 bn.

 

RBI may also attempt to rationalize the prudential norms (risk weights, provisioning requirements etc.) which can offer better incentives for credit disbursal.

 

Projections for FY10 likely to be conservative

Typically, RBI disseminates its estimate of inflation, growth in GDP, money supply and credit during the ensuing financial year for the first time in April. In the current round of the policy, we expect RBI to be conservative in its estimates. We believe, real GDP growth will be projected at ~6% and inflation at end-March 2010 at 4-5%.

 

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