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Published on 6/12/2018 12:26:42 PM | Source: ICICI Securities Ltd

Monetary Policy Update December 2018 - ICICI Sec

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Status quo as expected…

RBI maintained status quo on the policy repo rate, maintaining it at 6.5%, which was not as estimated by markets. The stance on calibrated tightening was maintained. Reverse repo rate was maintained at 6.25%. SLR was reduced 25 bps to 19.25% with aim to bring it down to 18% in line with LCR. CRR stable at 4%. Monetary policy decision to maintain stance of calibrated tightening was favoured by four committee members while a member Mr Dholakia had a view to change stance to neutral. The governor spelled out in his speech the chances of policy action (i.e. rate cut) in case upside risks to inflation do not materialise. This had a positive impact on 10 year G-Sec yields contracting almost 14 bps to 7.44%.


Key statements….

*   The RBI maintained the repo rate, MSF, bank rate at 6.5%, 6.75% and 6.75%, respectively

*  GDP growth projection for 2018-19 was retained at 7.4% vs. an expectation of some downward revision with risks broadly balanced. GDP growth for H1FY20 is now projected at 7.5% with some downside risk

*  Inflation is projected at 2.7-3.2%, down from 3.9-4.5% in H2 and 3.8-4.2% in H1FY20, with risks tilted to the upside

*  In a strong move, from April 1, 2019 RBI has asked banks to link all new retail floating rate loans and new MSE loans to external benchmarks like repo rate, GoI 91 day or 182 day T bills, or any other benchmark market interest rate produced by Financial Benchmark India Pvt Ltd. This can have an impact on NIMs over the medium term as in the near term only incremental housing loans will see linking of external benchmarks, bringing down lending rates

*  To ensure the market has liquidity data, RBI will share data on CRR holdings on a daily basis in its daily money market data release


RBI turning dovish….

The key takeaway from the RBI policy was the sharp reduction in inflation projection of around 80-130 bps. Effectively, the RBI indicated that medium term inflation seems to be around 4.0%, their medium term target. Therefore, this removes concerns on inflation. As the RBI believe that inflation for the next year is likely to be at their target levels, the stance needs to be neutral from current calibrated tightening. The other important monetary policy objective is to ensure real rate at around 1.5-2%. With inflation at 4% and normalised one-year T-bill yield at 6.75%, real rate would be 2.75%, much higher than RBI's target level. The same indicates that if crude oil prices remain at current levels and inflation remain as projected, we are in for a long pause or even a rate cut at a later stage.Bond markets have reacted positively after the policy with 10-year G-Sec yield falling sharply by around 14 bps to 7.44%. A sharp fall in US bond yields in the last few days has also supported the rally in Indian markets. The overall yield across G-Sec and good quality corporate bonds seems to have peaked out and may move lower in coming months. Corporate bonds offer relatively higher yield. With overall outlook positive on interest rate environment, accrual funds offer a good investment opportunity.


RBI on recent liquidity concerns and measures

RBI injected durable liquidity through OMOs amounting to | 360 billion in October and | 500 billion in November through open market purchase operations, bringing total durable liquidity injection to | 1.36 trillion for 2018-19. Liquidity injected under the LAF, on an average daily net basis, was | 560 billion in October, | 806 billion in November and | 105 billion in December (up to December 4).


RBI’s view on inflation...

« There have been several important developments since the October policy, which will have a bearing on the inflation outlook. First, despite a significant scaling down of inflation projections in the October policy primarily due to moderation in food inflation, subsequent readings have continued to surprise on the downside with the food group slipping into deflation. At a disaggregated level, deflation in pulses, vegetables and sugar widened, while cereals inflation moderated sequentially. The broadbased weakening of food prices imparts downward bias to the headline inflation trajectory, going forward. Secondly, in contrast to the food group, there has been a broad-based increase in inflation in non-food groups. Thirdly, international crude oil prices have declined sharply since the last policy; the price of Indian crude basket collapsed to below US$60 a barrel by end-November after touching US$85 a barrel in early October. However, selling prices, as reported by firms polled in the Reserve Bank’s latest IOS, are expected to edge up further in Q4 on the back of increased demand. Fourthly, global financial markets have continued to be volatile with EME currencies showing a somewhat appreciating bias in the last one month. Finally, the effect of the Seventh Central Pay Commission’s HRA increase has continued to wane along expected lines. Taking all these factors into consideration and assuming a normal monsoon in 2019, inflation is projected at 2.7-3.2% in H2:2018-19 and 3.8-4.2% in H1:2019- 20, with risks tilted to the upside (Chart 1). The projected inflation path remains unchanged after adjusting for the HRA impact of central government employees as this impact dissipates completely from December 2018 onwards. Although recent food inflation prints have surprised on the downside and prices of petroleum products have softened considerably, it is important to monitor their evolution closely and allow heightened short-term uncertainties to be resolved by incoming data. 20. »


RBI on external benchmarking of new retail loans

In a bid to move towards efficient transmission of monetary policy, RBI has recommended linking of loans to external benchmark instead of present system of using internal benchmark. Accordingly, it is proposed that new floating rate personal or retail loans (housing, auto, etc.) and Micro and Small Enterprises (MSME), extended from April 1, 2019, to be linked to an external benchmark. Banks can choose external benchmark from three options provided by RBI – Repo rate, 91 days T-bill rate or 180 days T-bill. Spread over the benchmark rate is to be decided at banks discretion at the inception of the loan. However, such spread needs to remain unchanged over the tenure of the loan, unless credit worthiness of borrower undergoes substantial change as agreed upon in the loan contract.

In our view, benchmarking the floating rate with external benchmark will lead to faster and efficient transmission of monetary policy and consumer loans will be more closer to market rates. At the same time, increase in volatility in lending rates could not be ruled out as external rates like T-bill, gsec rates are updated on a daily basis.

Assuming 12% incremental growth in new floating rate loans and a 50 bps cut in lending rate, led by external benchmark, FY20E PAT is seen to get impacted by 0.3-1.6%. Banks with higher proportion of home loan (including SBI, BoB) are seen to witness ~1% impact on bottom-line. Private banks, with relatively lower proportion of home loans are seen to witness marginal impact on FY20E PAT. 


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