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With bond yields at 18-month low, markets bet on Reserve Bank to cut rates once again

While policy rates have been reduced by 50 bps since February, average bank lending rates have declined by only 5 bps. Many banks have cut MCLR, but only by a symbolic 5-15 bps.

Written by George Mathew | Mumbai | Published: June 3, 2019 3:38:04 am
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After the 50 basis points cut in the Repo rate by the Reserve Bank of India since February, the central bank is likely to opt for another cut in the main policy interest rate at its Monetary Policy Committee (MPC) meeting on June 6, despite the banking system not fully passing on the benefits of the previous cuts to the customers.

Yields on benchmark government bonds have already fallen to a near 18-month low of 7.03 per cent as the markets are betting on sharper rate cuts in the current fiscal, with the new government getting ready for its first Union Budget on July 5, crude oil prices falling and growth rate declining.

Soumya Kanti Ghosh, group chief economic adviser, State Bank of India, said, “We are thus penciling a larger rate cut (35-50 bps) by RBI in the forthcoming policy. Interestingly, the RBI for the first time could use the rate change in non-multiples of 25 bps as a first step towards providing second generation signals to market of future policy stance. However, even such larger rate cuts will not help fully, but its transmission will. To this end, the RBI should now ensure following things.”

Lakshmi Iyer, chief investment officer (debt), Kotak Mahindra Mutual Fund, said, “Liquidity woes in banking system are far from over. The silver lining in this is the expectation of government spending … this is likely to reduce the liquidity deficit in the system. Also, the currency in circulation which had shown sharp spikes due to elections, is also likely to gradually recede, impacting liquidity favourably.”

“Given the global as also domestic scenario, the MPC may well choose to gratify the markets with a benchmark rate cut. What is more important for markets is the MPC guidance that the actual rate action,” she added.

According to bankers, asset and liability side of the banks should move in tandem and Repo rate should be directly benchmarked to external benchmark, non-volatile bank liabilities, CASA deposits that are mostly used for transaction purposes.

“Otherwise, we would continue to be constrained by lack of transmission, even as the RBI will continue to cut rates,” Ghosh said.

While policy rates have been reduced by 50 bps since February, average bank lending rates have declined by only 5 bps. Many banks have cut the marginal cost of funds based lending rate (MCLR), but only by a symbolic 5-15 bps. “State Bank of the India reduced the MCLR by 5 bps since February. In fact, several banks have increased deposit rates since February. Banks are not willing to cut rates as deposits and household financial savings are at historical lows,” Goldman Sachs said.

However, some bankers expect a status quo from the banking regulator in view of the Budget and monsoon.

“We expect the RBI to keep policy rates on hold during the June meeting. Our thinking is driven by five factors: uncertainty about oil prices, weak El Niño conditions, and its implications for south-west monsoon, with some evidence on firming up of wholesale and retail prices of food, incomplete transmission of the 50 bps reduction in the policy rate since February and therefore, a cautious wait and watch approach to make progress on more complete and faster transmission,” Goldman Sachs said in a report.

It added the Reserve Bank will “evaluate the implications of any new government policies for growth and inflation”. “Our call is in line with market expectation — market pricing of less than 50 per cent chance of a cut in policy rates in June. However, we do see continued liquidity injections to take place in the near term,” Goldman Sachs said.

Since the April monetary policy meeting, there have been several key developments that are likely to weigh on the RBI’s decision. On the external side, global growth continues to be soft.

The trade war is gearing up again, and poses a downside risk to our China and US growth forecasts. India’s headline consumer price index (CPI)-based inflation stayed flat at 2.9 per cent in April. The rise in food was offset by lower core and transport inflation in April. “We forecast average headline inflation to rise from 3.4 per cent in FY19 to 3.9 per cent in FY20,” Goldman Sachs said.

Indranil Sen Gupta of Bank of America Merrill Lynch said, “Looking ahead, we expect the RBI MPC to cut 35 bps (up from 25 bps earlier) on June 6 (and 100 bps in 2019) with May inflation tracking a low 3.3 per cent.”

“One can expect both liquidity measures and a rate cut. Rate cut expectation ranges from 25 bps to 50 bps. The central bank will see how the fiscal situation unfolds with the Budget announcement and spending measures. It will also take into account global factors, trade tensions, crude price trends, geopolitical equations and the monsoon outlook,” said Shanti Ekambaram, president—consumer banking, Kotak Mahindra Bank.

With the elections resulting in a decisive mandate, the attention will now shift to policy — both fiscal and monetary — with focus of spurring growth, boosting slowing consumption and attracting private investment. There may be some structural measures from a liquidity perspective, strengthening of the financial system framework and, of course, looking at rates in the current context of low inflation and flagging growth.

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