RBI surprised the consensus of the market by a 50 basis points Repo Rate cut in its Monetary Policy announced on Tuesday. The effective rate now stands at 6.75 per cent compared to 7.25 per cent earlier. This was indeed a pleasant surprise for all the markets — bond market, forex market and equity market. The surprise element came from the fact that recent RBI pronouncements on inflation and growth led the markets to anticipate a hawkish stance.
RBI, however, seems to have taken a different view based on the current fall in inflation, its future trajectory and the worsening global conditions since the last policy. The other factors that weighed in favour of a rate cut are the sustained lower commodity prices and Current Account Deficit which is getting contained by government actions. The markets have taken the above actions by RBI very positively, pulling the stock markets from a low of 7,692 level to 7,843 levels (NIFTY) and the Indian rupee by about 50 paise from its low of the day.
The Central Bank’s accommodative policy stance in the statement means that if future data permits, further easing is possible. It may be reasonable to expect more rate cuts in future, if the government succeeds in maintaining inflation within the comfort levels of RBI. The mildly negative rainfall for the current year may be offset by other factors mentioned above.
The direct effect of this action is to reduce the marginal cost of borrowing, which should aid the profitability margins of corporate and small businesses. The cost of borrowings for banks also should move down favourably. Banks that carry larger than mandated SLR investments would see a positive MTM valuation adding to the current year’s profit.
In the ordinary course of such RBI action, Indian rupee would have normally depreciated. However, RBI has proposed a few significant changes relating to ECB, issuance of Rupee Bonds, FPI investment in Government Securities etc, which lend a positive impact on Indian Rupee, thereby causing it to appreciate. RBI announced lowering of SLR securities held under HTM category to 21.50 per cent from January 2016 and later to 20.50 per cent over a period of one year through quarterly reductions of 25 basis points each. This is a welcome decision to free up mandatory holdings of banks allowing them to deploy funds profitably.
RBI also announced increase in FPI investment quota for Government securities to 5 per cent of outstanding stock in tranches by March 2018. FPIs can also invest in State Development Loans, with a limit of 2 per cent of stock outstanding by March 2018. This is the first time RBI is allowing FPI inflow in to Securities issued by State Governments.
The proposed reduction of risk weight applicable to individual housing loans will enable banks to pass on the benefit to borrowers in this segment. This will result in further pick up in retail loans, especially home loans.
The policy measures are, in short, very positive for individual borrowers and businesses as well as for financial institutions in improving the cost structure. The resultant pick up in investment activity and credit growth will obviously add momentum to economic growth.
V G Mathew MD & CEO, South Indian Bank