RBI Mid-Quarter Policy Review

Mid-quarter policy review: repo rate upped by 25 basis points, MSF rates reduced by 75 basis points

Newly appointed governor of Reserve Bank of India (RBI), Raghuram Rajan, delivered a surprise package in its mid-quarter policy review by raising the repo rate by 25 basis points and easing the short-term interest rates through reduction of 75 basis points in the marginal standing facility (MSF)/bank rate. Taking advantage of the improving global situation, the RBI has done a partial unwinding of the exceptional measures announced in July. It is taking efforts on reinstatement of repo rate as operational interest rate, which lost its relevance due to the tight liquidity and curbs on liquidity adjustment facility (LAF) borrowings. The reduction in MSF rate and the daily cash reserve ratio (CRR) requirements (95% from 99%) is likely to give some breathing space to the banks. However, the focus on retail inflation (not wholesale) and the hike in the repo/policy rate does indicate the continued hawkish stance. Moreover, the commentary also indicates the possibility of further rate hikes to narrow the gap between the repo/policy rate and MSF rate. 

Inflation concerns back on foreSince the inflation (Wholesale Price Index [WPI]) is again on an uptrend, the RBI expects upward risks to the inflation estimate of 5% for FY2014. According to the RBI, a persistent high Consumer Price Index (CPI) inflation, suppressed fuel inflation and volatility in exchange rates remain key concerns to the inflation outlook. Though the external environment threatens the current account deficit, the RBI suggested the government should focus on internal dynamics, such as fiscal deficit and inflation. Going ahead, we expect greater emphasis on inflation with respect to policy rates. Therefore, the interest rates are likely to remain firm, which could result in a downward revision in the gross domestic product (GDP) growth estimate.

Emphasis on resuming repo rate as operational interest rateThe RBI in the monetary policy statement expressed its intention to bring normalcy in monetary operations, which has been distorted on expectation of tapering by the US Federal Reserve (US Fed). The RBI wants the repo rate to resume its role as the operational policy rate, which has been occupied by MSF due to the tight liquidity and curbs on LAF borrowings. However, the deferment of tapering by the US Fed has raised uncertainties with regard to withdrawal of exceptional measures announced earlier.

Banking sector: NIMs pressure likely to continue for banksThe banks may slightly benefit at the operating level by the reduction in the MSF rate and easing of the CRR requirement (95% from 99% earlier) since the borrowings from the MSF window has increased and have been higher than the LAF (due to curbs on the LAF borrowings). However, an increase in the repo rate has pushed up the bond yields and raised the uncertainty with respect to interest rates. This could impact the investment cycle and credit offtake from banks. Also, as the busy season kicks in, the liquidity tightness will add pressure to the short-term and deposit rates, which in turn will impact the net interest margins of the banks. Going ahead, the banks may shore up the base rates (due to a rise in the cost of funds) to mitigate the margin pressure.

Source - Sharekhan Newsletter

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