D-Street Awaits RBI Credit Policy, Expectations Pinned

Today’s RBI credit policy holds special significance against the scenery of the demonetization announcement on November 8, 2016. The RBI has been generally silent since then except for the regular notifications and press releases. The policy gives it a prospect to outline its thoughts and inform the public on the implications of demonetization for the economy. 

The Monetary Policy Committee (MPC) is meeting at a time when countless issues have come to the forefront:

1. Canceling legal tender of Rs500 and Rs1000 denomination notes,
2. Spiking of global bond yields sharply and
3. Weakening of INR due to a combination of domestic and global factors.

The call on the repo rate should take into perception risks of growth slowdown, comfort on inflation and risks of INR volatility from sharp contraction in real interest rate differential. It is believed that the RBI will exercise caution in its December policy and reduce repo rate by 50 bps. This will support growth dynamics without any major risks of adverse Forex Dynamic.

On the Dalal Street:

Dalal Street investors are eagerly awaiting the outcome of the Reserve Bank of India’s (RBIs) fifth bi-monthly money policy review, which concludes today.  Holding its breath, yesterday Nifty share price closed at 8143, waiting for the Policy as well.

A 50 basis points rate cut tops the wish list of the D-Street, which is higher than the agreed estimate of 25 basis points cut that many believe the market has mostly factored in by now.  But more than that Dalal Street would love to hear from RBI Governor Urjit Patel what kind of effect the central bank sees on the FY17 GDP growth and also on inflation due to the demonetization drive.

The timing of a possible phase out of the incremental CRR limit imposed by RBI to handle the extra liquidity in the system is another important point investors would want Patel to communicate in order to offer more lucidity on the state of the economy.

The rate cut:

The market looks almost sure that RBI will deliver a 25 basis points (bps) rate cut but If RBI does end up bringing the rate down by over 50 bps; it would certainly astonish the market. And the justification here could be that if the 100 per cent CRR limit is scaled down or removed, then RBI would have the room to bring down the rate of interest. Current bond yields would also get attuned to the fall in the rate of interest, which has gone down due to the high liquidity in the system. All put together, RBI has a favorable equation as of now.

Impact of Demonetization on growth:

The market has not had much clarity or guidance on that at all, which in itself is surprising. One of the points that clearly would still be highlighted is the component of uncertainty. So while sitting in the trenches in financial markets, the market does not have the luxury of just putting on blinkers and seeing through the next six months to look at what the influence would be.  It would make sense for RBI to offer some direction no matter how lower chance of that playing out in terms of what the hit to growth is.

Inflation and Policy:

Experts believe that demonetization is likely to bring down inflation, which should be supportive of lower rates. Glancing at the commentary of economists across the board, everybody talks of GDP growth outlook having gotten impaired. That supports to some extent lower interest rates. So the market should expect a reasonably dovish commentary from RBI.

Beyond the Rate Cut:

Beyond the rate cut call, there are questions which at the current moment can be very important. Answering these crucial questions will provide some comfort to the markets and the economy in general.

1. What is the status of printing notes especially of Rs500?
2. What is the capacity of the mints for printing notes?
3. What is the short term impact on the economy -growth, inflation, and money supply?
4. How does the RBI view the liquidity situation?

The RBI may not essentially answer all of them given the nature of its operations. But, the crux of the policy will be beyond the sphere of just monetary policy. The credit policy has conventionally seen the RBI’s role as the monetary authority and regulator of the financial system. It will possibly be as important to see the RBI in its role as the issuer of currency, even if it is not a part of the policy announcement today.