Unchanged Rate Of Interest May Dampen Investors’ Mood

Urjit Patel was nervous and not comfortable in the afternoon hours of December 7 facing tough media questions from a bundle of journalists gathered at the headquarters of country’s apex bank in Mumbai. Patel, considered to be a hand-picked man of none other than India’s Prime Minister, Narendra Modi did not go for a rate cut contrary to the wide speculations on Dalal Street since last fortnight about a possible rate cut by at least 25 bps. Some had even gone one step forward and talked about a possible 50 bps cut. Sharp at 2.30pm when Patel armed with his deputies announced ‘no change’ in present interest regime, Sensex witnessed a quick freefall by over 250 points only to regain half of it later.

A strong sense of criticism immediately followed Patel on social media and online media. A rate cut was needed considering banks are sitting on flush of funds, most of the critics claimed. But Patel must be having his own set of logic and so are other members of the MPC. The rate cut was called for; many events simultaneously forced its happening. With demonetisation, 86 per cent of currency circulation was frozen resulting in liquidity crunch in the economy. 

Post event, international rating agencies downgraded the Gross Value Added (GVA) 2016-17 to 6.9 per cent from prior 7.4 per cent. Meanwhile, RBI also revised its target for GVA of the country to 7.1 per cent from earlier 7.6 per cent. At the global front, the expected interest rate hike by FED and weakening of rupee provoked the happening. At market level, Bond benchmark yield dropped to 6.11 per cent from the prior level of 6.8 per cent, with sell-off G-secs by FIIs. Obviously, Indian equity markets witnessed a fall of approximately 5.4 per cent in the whole scenario. The six-member Monetary Policy Committee (MPC), headed by Patel, announced its fifth bi-monthly statement 2016-17. ‘No change’ was immediately justified stating that after a calibrated policy judgement of 25 basis rate cut in the repo rate in October 2016 policy, cumulating 175 basis since January 2015, consecutive cut was not warranted. 

Drop in October inflation rate and expected further drop in Q4FY17 indicated the cut then. Post October policy, though the retail inflation in Oct 2016 eased to 4.2 per cent on the back of softening food prices with WPI dropped to 3.39 per cent, the recent firming of food grain prices and crude oil output cut decision taken by OPEC may bring in the reversal in the inflation rate. The MPC committee is looking forward to a target of 5 per cent inflation in Q4FY17 and will further be liable for any rate change on its achievement. On the global front, also, the FED’s move of interest rate hike has already factored in and RBI would want to think in that direction only after it gets clarity with further data in hand. 

In the prior policy of October, 2016, assurances on improvement in the asset quality in last policy was partially achieved. As per the September quarter results from the banks, with the incremental percentage of gross and net NPA, though banking system has witnessed marginal reduction in restructured advances and slight uptick in stressed assets, the pace of formation of incremental NPA has slowed, provision coverage has improved and banks saw better recoveries in H1FY17 as against H1FY16 with reduced write off.

Flashback to when our Prime Minister announced demonetisation as a surgical strike on black money. The banks were flooded with CASA post deposit of Rs.11.85 lakh crore worth 500 and 1000 notes on December 7. Talking about cash reserve ratio (CRR), RBI is unlikely to contrivance to apply the incremental cash reserve ratio after increase in Market Stabilisation Scheme (MSS) ceiling to Rs.6 lakh crore from Rs.30,000 crore. RBI had announced an incremental cash reserve ratio (CRR) of 100 per cent of the increase in net demand and time liabilities (NDTL) of scheduled banks to absorb liquidity glut in the system. 

The incremental CRR was purely a provisional way-out. Thereby, it was decided in the policy to withdraw the CRR on December 10. Thereafter the released money would be absorbed partly for Market Stabilisation Scheme (MSS) bond issuances and partly for liquidity adjustment facility (LAF) operations. During the tenure, the money flow in the economy was not stopped and banks nearly supplied Rs.19.1 billion to the public which was more than the total supply done in last three years by it, where the actual amount deposits amounted to Rs.13 lakh crore. RBI demands people to continue to stick to the cashless payment system. There has not any clarity been given on how much deficit in cash, how much more money is required to be printed and removal of withdrawal limit for now. The decision to issue of Rs.2000 notes was purely taken based on historical analysis of people’s transacting pattern i.e. the average requirement.The infusion of new Rs.500 and Rs.100 notes are expected to improve liquidity and encourage circulation of the Rs.2000 notes already in the market.

FIRST STEP TOWARDS DIGITALISATION:

Going forward bank account portability can be achieved by joining Adhaar to the bank accounts. Digitalisation will lead to more transparency and collateral benefit, public finances will improve and ultimately reduce the cost of printing money. Another move came from RBI, as black money not going back to the central bank, its liabilities would substantially reduce to the extent of old notes not deposited. Hence the differential would be transferred to the government and not supplied within the banking system. Resultant, there will not be any special dividend to RBI.

HOW WILL THE MARKETS REACT IN NEAR-TERM? 

The impact of RBI monetary policy on Indian capital markets not to be warry enough as there is still a chaos going on surrounding the banks and account holders. The central bank may not have come forward with a positive gesture and still want to settle down the dust of demonetisation till end of the current calendar year. If at all RBI wants to cut down the rates it will do as a big decision of demonetisation taken in month of November, 2016. The next bi-monthly policy to fall after union budget for FY18, the central bank may oversee reforms and decisions from government after such a bold move.

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Sectoral impacts:
 
Various sectors which are directly related to RBI policy are Banking, Automobile, Housing Finance Companies and Construction, which can be elaborated below:

Automobile: Though there is no rate cut from RBI, there will not be any chance of reduction in the sales of the sector. However some of the companies' sales have been affected due to demonetisation impact, but that is just a short term phenomenon.

Real Estate: The sectoral index has been beaten down the most after demonetisation owing to fear of declining realty prices in both commercial and homes segment. But organised companies, which are listed players need not worry as most of the payment comes in the form of cheques.

Housing Finance Companies: Housing Finance companies’ scenario has also been dampened due to demonetisation, for the short term. There may be increase in non-performing assets for couple of quarters. Even if the central bank does not cut rates, there will be no sharp decline in disbursing of home loans.

Banking: Banking sector specific stocks will remain in focus as positive guidelines came from RBI to tackle situation of demonetisation. For long term banking to remain bullish due to prospect of incremental financial inclusion in the country.