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The Summary of the RBI Policy Today, In Which They Did Not Cut Rates

RBI did not cut rates today, like we had expected them not to. There was no reason to cut, and in fact more reasons not to. What the RBI said was:

  • We’re not cutting rates
  • Banks should cut rates first
  • We did 0.75%, bank average cut is only 0.30%
  • Plus the monsoon started well but doesn’t seem to be all that great.
  • And stuff in China isn’t good either.
  • “Bond market sell-offs originating in Germany lifted bond yields across the world, including in EMEs”

The Gist

No one expected them to cut rates, and they did not. That sums it up.

Isn’t there more? Aren’t you supposed to analyze everything like his hand movements and all that?

Get over it. There isn’t anything big.

Except this.

Inflation’s been going up. Rajan said this today in the policy statement:

Headline consumer price index (CPI) inflation rose for the second successive month in June 2015 to a nine-month high on the back of a broad based increase in upside pressures, belying consensus expectations. The sharp month-on-month increase in food and non-food items overwhelmed the sizable ‘base effect’ in that month.

We mentioned this in Macronomics (Premium only) yesterday, with this graph:

Monthly Trend

What this shows is that month-on-month, inflation’s been rising and when this “base effect” of lower crude prices is over (Post October 2015) we might see inflation actually begin to rise.

That’s not good news, at all.


The Story Ends?

Well, let’s tell you a secret. It didn’t matter that the RBI didn’t cut rates. Because a rate cut would be about cutting the overnight borrowing rates of banks. Banks , though, are not borrowing from the RBI overnight.

They are keeping excess money with the RBI overnight.

In fact, a whopping 76,000 crore rupees was kept with the RBI yesterday. This is the highest in two years. Here’s the overnight and short term borrowing system between banks and RBI:


Banks are choosing to park cash (at 7.24%) with the RBI instead of lending money out; that in effect tells you why the rate cut was useless. It’s not that banks can’t get lower rates of borrowing, it’s that they are refusing to lend.

That was why this rate cut expectation was simply overblown.

  • Ramki says:

    3 More observations worth a thought IMO:
    * Crude Oil has plunged from 65$ whereabouts to 50$ in last 3 months, so the effect will be on lower fuel prices and lowered CPI nos in August to October (than in past). Some 10% or so fuel price reduction is not small no to scoff at
    * Food inflation is concern but kharif planting better than last year (though less than 2013) plus reservoir levels better means food inflation may have peaked. So worst of CPI hike is gone.
    * The last chart indicates banks are returning money to RBI (which issues money in first place), meaning monetary supply is indicating contraction (right to interpret that way)? Unless Government indulges in some spending binge, some deflation is getting into the system ???!!!

    • 1) Crude oil could change the pattern yes, if 10% happens. Some of it already has, and some more should as well.
      2) Planting is one thing but the harvest is another. Some of the concern is in the south.
      3) Monetary supply doesn’t really show contraction at this point, but yes, growth in monetary terms has reduced substantially. Which is probably a by-product of lower inflation.
      You could be spot on – that the uptick in inflation is temporary and that things will change going forward. And hoenstly I hope you’re right – we need to have broken the back of inflation before we move ahead.

  • rkg says:

    To pay 7.24% (by RBI) to the system that has 70odd-k cr of excess liquidity is by itself a policy anomaly. Why supporting banks with such a high rate – as a result, all risk free rates (TBill yields) are upwards of 7.40 and an incentive to shun core lending. You would really see a big shift once the floor is removed. Today Banks have a nearly guaranteed return upwards of 7% on overnight money
    I could be wrong but my question is why taking the spot rate (repo rate) to determine what is a real interest (differential). Currently at about 1.75% (Repo minus Inflation), it is within the RBI’s stated 1.50-2.0% corridor. Actually, a retail depositor gets somewhere around 8% for 1 year bank deposit (which should be a better benchmark rather than the Repo rate imho)

    • Good question; risk free yields at 7.4% is definitely above cost of capital no? Maybe reducing rates can hurt banks in that manner 🙂
      I don’t know if RBI has a stated corridor for real rates. It does have an inflation target (4% +- 2%) but not really sure if there is a real rate target at all.

  • Gaurav says:

    So why is the transmission mechanism not functioning as it should? Is it the NPA’s that are currently in the system? Or is it because banks are just trying to get a better capital buffer due to regulations? Or something else entirely.
    Wonder if the solution is better regulations – such as a clear bankruptcy code, or some movement on fiscal spends by the government (especially since the deficit is now lower). The worry though with fiscal policy is will we know its effective or just a sheer waste.
    Curious about your thoughts in this regard.

    • Simple, I think we don’t have enough banks with incentives to compete. The private banks are doing well, the public banks are screwed and they are the majority.
      Bankruptcy code will work but it could easily kill a few banks (which is a good thing). Fiscal spends are happening but very slowly and we shouldn’t depend on them.

  • rkg says:

    Thanks Deepak. On Real Interest rates, i was rather guided by this statement in one of the post-policy telecons.
    This was Dr Rajan’s statement to one of the questions on real interest rates:
    “….Now where do we see real interest rates go? I mean it obviously depends on the stage of the cycle and the stage of development also to some extent. Today, world real interest rates are about between 1.5% and 2% depending on the country that you go to; I am talking about long-term real interest rates. So my guess is that would be approximately where we would go in the normal phase of the cycle.”

    • Ah, that’s not a stated goal. In fact real rates are not a goal at all, they just happen. This is wehre we could go in normal phases, but we have been abnormal for many years (real rates <0) and we could have much higher real reates (3%?) in years to come because thigns do go to extremes in both directions.

  • rkg says:

    Lest i be mistaken for spamming – one of the main reasons for a weaker rate transmission is that, today, Credit Cost has gone up. It surely is a function of the growing NPAs. And secondly, the way banks calculate their cost of funds is more scientific and provides for almost all factors that were once ignored. Cost of doing business has increased (a US Bank will say the say as the amount of monies spent on compliance and technology is huge).
    As someone closely involved and responsible for asset pricing, i am not finding it easy to transmit a 75 basis rate cut into my base rate…:(

    • If a bank has NPAs then it’s a capital issue – the immediate need then is to raise more capital to compensate, not to keep lending rates higher.
      Calculating cost of funds might be scientific but the approach to lowering cost of funds is tactical. For insance if you had taken OIS for deposit covers a long time back (when it was obvious that Rajan would cut rates) then the cost of funds now would easily be 75 bps less at least on deposits.
      Cost of doing business in terms of compliance is next to nothing in India compared to US cost, and remember there they have paid billions of dollars in fines for doing the wrong things. Indian authorities have hardly fined banks, even if they are blatantly misselling, because banks seem to be able to get away with it here.
      I can be honest – if a bank with 3% NIMs cannot find it easy to transmit a 75 bps cut into base rates, then that bank is doing something seriously wrong. It needs to raise capital now, and get competitive. If a new bank comess in today they can price loans at lower NIMs and far lower base rates – then where will your bank be?

  • Gaurav says:

    Hi Deepak, this is a great post and discussion!
    Your competition point is a great one – didn’t even realize it. To add to that, perhaps the competition should also be not just banks, but also alternate sources of funding. A broader corporate bond market perhaps. Greater funding from NBFC’s? But even that isn’t enough.
    Even if banks are saying compliance costs have increased – and maybe they have – the industry is due for some disruption. No wonder banks have been pulling up the Nifty!

    • Yes, already competition is beating them in the big corporate loan area. Corporates have increased the total outstanding commercial paper by over 100,000 cr. (50%!) in the last year.
      NBFCs do fund corporates sometimes but their cost of funds then are typically banks as they have no CASA and have to survive on deposits (which are technically more expensive) Mutual funds (liquid etc) are potentially competition because they get money from retail and push out to corporate through the bond/cd markets.