The RBI monetary policy announced on June 06th was largely on anticipated lines. To begin with, it was slightly more hawkish as compared to the April policy since the June policy was constantly emphasizing on the risk of higher inflation. Secondly, the policy came at a time when the RBI was unhappy with the extent of transmission of rate cuts and was expecting the AQR and the MCLR to bridge this gap. The current monetary policy was announced ahead of 2 major global events; US FOMC meet on June 15th and the BREXIT referendum in UK on June 23rd. Both these events could have larger repercussions for the monetary policy stance of the RBI as well as for currency and money markets. It is in this light that the policy needs to be seen and understood.
Highlights of the Monetary Policy announcement…
- The repo rate has been maintained at 6.5%
- The cash reserve ratio (CRR) has been maintained at 4% of net demand and time liabilities (NDTL)
- RBI will continue to focus on reducing the liquidity gap in the system with calibrated open market operations (OMOs)
- Consequently, the reverse repo rate remains at 6% and the Bank rate at 7%. Remember that in the previous policy, the RBI had reduced the spread between repo rate and bank rate from 100 bps to 50 bps.
Greater focus of the RBI on liquidity…
What the RBI has done in this policy is shift the focus of the policy more in favour of liquidity management than just rate setting. Over the last 3 months, the RBI has reduced the liquidity shortfall in the system from Rs.200,000 crore to Rs.65,000 crore. This has been achieved by open market operations (OMOs) by the RBI wherein it buys securities to infuse liquidity in the system. The outcome of this sharp fall in the liquidity shortfall means that yields will come down further at the short end of the yield curve. Basically we could see a fall in money market rates, T-bill rates and rates on Commercial paper (CP) and certificates of deposit (CD). This liquidity management becomes very important because between September and November, there will be an outflow of nearly $30 billion due to maturing of FCNR deposits. This will lead to increasing competition among banks for domestic deposits leading to further tightness in the money market and higher yields. The RBI proposes to bring down this liquidity deficit even further to take care of this huge outflow from September.
Global cues have impacted RBI decision…
There are two key global events coming up in the month of June. Firstly, the US FOMC will meet on June 14-15 to take a view on Fed rates. The Non-farm payrolls (NFP) data has shown weak growth in employment and wages and hence the Fed would ideally not be too keen on hiking rates in this kind of a weak economic scenario. However, the tone and trajectory of the Fed will be closely watched to gather hints of whether the Fed would actually back-end the rate hike. Also, Janet Yellen has kept the markets guessing without committing on the timing of the rate hikes.
The other important trigger for the RBI would be the British Exit (BREXIT) from the EU. The pro-exit camp has been gathering momentum and has moved into a majority in the latest polls. It could have quite a few repercussions. The UK£ could see a sharp dip in currency markets and this could rub-off on other markets. There could be a long/short trade with traders preferring to go long on European bonds and short on UK bonds. The RBI would surely prefer to wait out this outcome.
Finally, it was all about inflation…
At the end of the day, the core message of the RBI was that it was all about inflation. With inflation rising sharply by 56 bps to 5.39% in April 2016, the RBI is surely worried about the inflation risks to the economy. Also it is food inflation that is the culprit and the RBI knows that it is the stickiest aspect of retail inflation. With oil and commodities showing smart gains, they could easily contribute their might to inflation. The RBI would rather wait for the base effect to wear off and cut rates once the inflation starts coming off from August onwards.
The June policy is surely more hawkish than the April policy. However, the trajectory painted by the RBI is still dovish on rates in the long run. Secondly, by focusing on liquidity, this policy is a lot more accommodative, apart from purely being hawkish or dovish. A status quo from the FOMC and the failure of BREXIT vote could be the ammunition for the RBI to go ahead and cut rates. But for that, we will have to wait till the next policy on August 09th.