Liquidity Steps Should Materially Help in Transmission of Rate Cuts
The yet another 25 basis points cut in repo rate by the RBI and an accommodative policy commentary were in line with expectations. But, the highlight — and a pleasant surprise — of Gover nor RaghuramRajan’spolicyisthesupporthe extends to banking system liquidity.
The policy could be seen as an inflection point in RBI’s stance on liquidity — the central bank now decides to progressively lower the average ex ante systemic liquidity deficit from the current 1% of NDTL to a position closer to neutrality. A back-of-the-envelope calculation suggests this might lead to liquidity infusion of about ₹ 1 trillion by the RBI in the coming months. We welcome this change in RBI’s stance and believe it should materially help in transmission of rate cuts, apart from supporting multiple asset classes in India. In effect, the impact of the RBI policy should be seen as far stronger than just another 25 bps repo rate cut.
The RBI has now cumulatively cut repo rate by 150 bps in 15 months. We expect another 25 bps repo rate (or modestly larger) cut in 2016. Nevertheless, currently, the central bank has relatively few ‘rate cut bullets’ left in the near term. At this juncture, thus, the RBI’s change in policy framework and focus on liquidity infusion, likely primarily through OMOs, is a significant move. The RBI has been markedly cautious as regards injection of liquidity in the recent past. For instance, reserve money growth — which reflects the central bank’s injection of primary liquidity — averaged merely about 7.5% year-on-year during the four-year period of 2012-2015, way too low compared with its longer-term average of around 13%. Historically, the quantum channel played a major role in India and liquidity infusion by the RBI in coming months should also be a strong catalyst in transmission of its ongoing monetary easing.
As regards future guidance, the RBI commentary continues to underscore the data-dependent nature of monetary policy action while maintaining an accommodative bias. While the global backdrop remains challenging, India’s domestic macro-fundamentals remain conducive for an accommodative monetary policy stance. Inflation stays benign — CPI will likely undershoot the central bank’s ‘target’ of 5% in 2016. WPI inflation has already recorded year-on-year contractions for 16 consecutive months, a pattern not witnessed in over four decades. Demand-driven pressure on inflation remains largely absent. Although the rupee is likely to weaken against the US dollar in 2016, it is not expected to materially alter the otherwise subdued inflation trajectory. Recovery in economic activities remains modest, with a markedly subdued private capex cycle. Thus, the seemingly high headline GDP growth should also not be seen as any obstacle for monetary easing given the upside bias in the ‘new’ GDP series.