Monetary Policy - Comprehensive set of liquidity measures: AnandRathi Financial Services

Mr. Sujan Hajra(Chief Economist- AnandRathi Financial Services) on Monetary Policy - Comprehensive set of liquidity measures

In the first monetary-policy statement of FY17, the RBI embarked on a raft of changes in policy rates and stance. It reduced the former by 25bps, alongside narrowing the corridor between the repo-reverse repo and the marginal standing facility-repo. The alteration in monetary-policy approach signals it now wants to bring liquidity to a neutral position. We expect liquidity to be improved by open-market operations (OMO). 10-year bond yields are likely to improve to 7-7.25%. The changes would be positive for banks, interest-sensitive sectors, solvent corporate high leverage and retail borrowers.

Performance. The RBI cut the repo rate by 25bps to 6.5%, and raised the reverse repo rate by 25bps to 6%. The Marginal Standing Facility (MSF) has been reduced by 75bps. Now the difference, therefore, between the repo and reverse repo has been reduced (from 100 to 50bps) and between the marginal standing facility and the repo from 100 to 50bps. The Statutory Liquidity Ratio (SLR) has also been trimmed, by 25bps to 21.25%.

Assessment. The 25bp cut in the rate is the least important of the measures initiated by the RBI policy today. More important are the liquidity measures, signalling fundamental changes in the monetary-policy approach. Since 2010, the RBI has kept the banking system liquidity in a deficit but it now wants to bring this to neutral. The narrowing of the money-market corridor implies that volatility in the money-market rate would ease and banks would be more relaxed in lending even if the deposit growth rate is low, as the penal rate under the MSF for over-borrowing from the RBI has been brought down.

Outlook. The lowering of the penalty (the difference between the MSF and the repo rates) for over-deployment (credit and investment) of funds by banks beyond their own mobilized resources (deposits and borrowings) implies that banks are being encouraged to step up credit growth even if deposit growth (or market borrowings) are subdued for some time. We expect the RBI to inject liquidity (OMO) if there is a large non-transitory liquidity deficit. The relaxation of the norms on the daily maintenance Cash Reserve Ratio balance with the RBI would also render liquidity management by banks easier.

Recommendation. The measures announced today (neutral liquidity balance and narrower money-market corridor) are likely to improve the transmission mechanism and banks are likely to cut both deposit and lending rates. We feel that despite the over-supply concerns in the bond market, with the liquidity infusion by the RBI through OMO, bond yields would not harden. In fact, in line with the rate cuts by the RBI and with better transmission, bond yields are likely to soften. We expect the 10-year yield to move in the 7-7.25% range. Today's move is also positive for banks, interest-sensitive sectors, solvent corporate high leverage and retail borrowers.

Source : Equity Bulls

Keywords