‘RBI Policy A Slap On Hawks - Party Set To Continue’

The report has been authored by

Dr. Soumya Kanti Ghosh, Chief Economic Adviser & GM, Economic Research Department, SBI.

Brief highlights of the report:

The decision to cut repo rate by 50 basis points was a bold and pragmatic move. At SBI, we had penciled in a 25 bp rate cut, but had anticipated an outside chance of a further 25 bp. This is the first standalone 50 bps cut in Repo rate since April 2012. This rate cut has been conditioned upon the fact that that there is a need to look inwards for comple-menting external demand with domestic demand and prevent any further buildup of domestic excess capacity.

The impact of repo cut and other developmental and regulatory measures will be incrementally positive for banking and economy and will be seen in short to medium term period. In order to transmit policy rates, SBI has slashed its base rate by 40 bps to 9.30%. With this, SBI slashed base rate by 70 bps in 2015, which is around 60% of the repo rate cut by RBI (40% of deposits are interest agnostic), indicating full transmission.

Overall, the policy announcement has a slew of positive surprises with the most notable being the projection of a benign inflation trajectory even throughout FY17 and reaffirmation of a continued accommodative policy. RBI has given clear indication regarding the 1-year ahead 10-year G-sec yield. Our estimates indicate that G-sec yield would come down to the range of 7.1%-7.2% from the current level of 7.70%. Even in the near term, yields would breach 7.50% level.

While on the one hand, the reduction in SLR and HTM will reduce the LCR pressure, on the other hand increase in FPI limit both in G-secs and SDL will create addition demand for SLR securities,. However, the additional demand would be eaten away by cut in SLR to some extent.

Reduction in risk-weight on low-cost home loans will release capital for banks and also help in transmit the interest rates, as 70% of large PSBs housing portfolio comprises of low-value. An estimate suggest that 10% reduction in risk-weights lead to minimum Rs 4200 crore additional capital for banks.

The good thing is that this rate cut may not be the end of easing cycle, and there may be more in FY16. Consider the following fact. RBI in its latest Annual Report has indicated that the risk free natural real interest rate for Q4 FY15 was in the range of 0.6% to 3.1% (it is time varying). This is different from 1.5% to 2% that the RBI has earlier set out. The crux of this estimate is that if GDP is lower than predicted, the estimate of the natural rate is lowered. Given that the RBI has actually lowered the GDP forecast in the current fiscal, the real rate of interest currently is possibly lower than the lower band at 1.5%, indicating the room for RBI to cut repo rate further from 6.75% (even after assuming inflation at 5-5.5% )!