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What We Did Not Expect, Happened: 50 Basis Point Rate Cut!


RBI has cut rates by 50 basis points – which is 0.50%. That means everything is cheaper! Even in stock markets! (Nifty is currently lower. But it’s seriously crazy so who knows where it will be by the time I finish writing)

So the history is like this, and from today, the repo rate will be 6.75%


Repo is the rate at which banks borrow for their requirements from RBI overnight. In recent times, banks have only parked excess cash with the RBI, so this rate may make no difference. Even today, after the rate cut, when there was a repo auction for 15,000 cr. the banks only took 8,000 cr. of it:

image This rate cut won’t make a difference immediately but it will require them to cut rates.

Outlook: Not good for world, and we have to stoke demand for India

The summary of the statement is:

Since our last review, the bulk of our conditions for further accommodation have been met. The January 2016 target of 6 per cent inflation is likely to be achieved. In the monetary policy statement of April 2015, the Reserve Bank said that it would strive to reach the mid-point of the inflation band by the end of fiscal 2017- 18. Therefore, the focus should now shift to bringing inflation to around 5 per cent by the end of fiscal 2016-17. In this context, the weakening of global activity since our last review suggests that commodity prices will remain contained for a while. Still-low industrial capacity utilisation indicates more domestic demand is needed to substitute for weakening global demand in order that the domestic investment cycle picks up. The coming Pay Commission Report could add substantial fiscal stimulus to domestic demand, but the government has reaffirmed its desire to respect its fiscal targets and improve the quality of its spending. Under these circumstances, monetary policy has to be accommodative to the extent possible, given its inflation goals, while recognizing that continuing policy implementation, structural reforms and corporate actions leading to higher productivity will be the primary impetus for sustainable growth.

Furthermore, investment is likely to respond more strongly if there is more certainty about the extent of monetary stimulus in the pipeline, even if transmission is slow. Therefore, the Reserve Bank has front-loaded policy action by a reduction in the policy rate by 50 basis points.

What this says is that Rajan would have done 0.25% but decided to “front load” again. Which means he doesn’t expect to do it next time unless of course the data gets really bad.

Also, the deal is to stoke local demand which doesn’t seem to be picking up.

The note about the Pay Commission report is important too. If that increases the purchasing power of a large number of government employees (and pensioners) we will see demand pick up yet again.


The Small Other Things

The policy had more pieces.

RBI will ask government to reduce the small savings rates (Post office deposits, NSC, PPF etc) because banks compete with them for savings and therefore have to keep deposit rates high. This means your interest rates on savings will fall substantially.

Smaller housing loans will get a lower risk weight than the current 50% being given to loans for houses that cost less than 25 lakh. We don’t know how low just yet.

Banks are allowed to mark bonds upto 22% of of their assets as “Held to Maturity” meaning they don’t need to take any losses if the prices of the bonds fall. This limit, along with the Statutory Liquidity Ratio (minimum % of assets they have to hold in govt bonds, currently 21.5%) will be brought down. The HTM limit will be brought to 21.5% in Jan 2016, and from March 2016, SLR and HTM will both be reduced by 0.25% every quarter till March 2017.

That means we will see SLR at 20.5% in March 2017, which is 1% lower than today. 1% is a lot – about 90,000 cr. – but this will make no difference because banks are investing WAY more than they should be, in to government bonds.

Foreign Investors will be allowed a lot more investment in Government Bonds. Currently they are allowed about 153,000 cr. of holdings, which they have maxed out. The limit is announced in USD but at a fixed exchange rate. It will henceforth be announced in rupees (thank goodness – who announces a dollar limit for a rupee bond?)

The limit will be increased by Rs. 13,000 cr. on October 12, 2015 and then again on Jan 1, 2015 – a total of Rs. 26,000 cr. for foreign investors in Government Bonds.

Additionally, FPIs will be able to buy Rs. 3,500 cr. of State Government Bonds on each of the two dates, totalling Rs. 7,000 cr.

Apart from the INR futures with currencies, RBI will allow exchanges to trade the larger currency pairs of EUR-USD, GBP-USD and USD-JPY.

Hedging or speculating in currency will become easier as the RBI won’t ask for “underlying exposure” upto $1 million, and might allow “smart financial investors” to speculate.

Masala Bonds

Corporates can issue rupee denominated bonds abroad, and that’s what’s named that horrendous name. Minimum maturity: 5 years. Holders will have to buy within the limit of $51 billion. Foreign investors can hedge the rupee risk in India but they have to come here.

Our View: Good, Now Back To Defaults

This is good, a 50 bps cut. But it means:

  • You have to deal with reduced interest rates on deposits.
  • The government could even cut PPF and NSC rates.
  • You will be able to borrow cheaper.
  • Banks will have to cut rates. SBI has already cut 0.4% today.
  • No more excuses for banks: The defaults have started and they will take centerstage now.
  • Things abroad are not at all very good. India will have to drive demand.
  • Real estate at the ultra cheap end may become exciting if the weight-cut has an impact. We dont have details.

We think markets will fall regardless. That’s because markets don’t really think this is a big deal yet.

The best part of the press conference was:


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