Monetary Policy: RBI's front loaded action - Views on News from Equitymaster

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Monetary Policy: RBI's front loaded action

Sep 29, 2015

"Home loans to get cheaper!"

"5 rate sensitive stocks to bet on..."

Unfortunately our analysis of the RBI's policy actions is not as deep!

But what we must tell is which part of the assumptions that have gone into the making of the policy decision must be ignored and which mustn't.

As if a shout out to FM Jaitley that it has 'done the best it can', the RBI aggressive 0.5% cut in repo rate comes unexpected.

Apart from its hawkish inflation stance, the RBI has been averse to lower rates due to two key factors:

  • The possibility of global interest costs heading upwards in response to rate hike by the US Fed
  • The possibility of asset quality pain in Indian banks getting camouflaged with lower rates.

As we already know, the Fed's moves are anybody's guess and the asset quality pain in Indian banks will take time to get undone, irrespective of the rates.

Hence, as the RBI itself has declared, its policy action this time is 'front loaded'.

What that means is the 0.5% cut in interest rates was not immediately called for. And as we can guess, may have been a very reluctant move. The increasing pressure from the Finance Ministry and the corporate lobby may have resulted in the central banking giving in.

However, there are also some solid assumptions behind the big ticket cut:

  • More domestic demand will substitute weakening global demand and in turn help the domestic investment cycle to pick up.
  • Corporate capex plans are likely to respond more strongly if there is more certainty about the extent of monetary stimulus in the pipeline, even if transmission is slow.
  • Commodity prices will remain benign in the medium term and therefore allow the central bank to ignore the inflation demon.

Any of these assumptions not panning out on the expected lines could throw the RBI's monetary policy stance off the gear. And in such a case, investors be forewarned that the RBI will not refrain from undoing its generous act.

Rate cut for a country of savers or borrowers?

You should understand that in the current scenario, the dynamics of the global economy support borrowers over savers. Be it in the US, Japan or China, safeguarding the interest of borrowers has been of utmost importance. And therefore the rationale of the RBI's reluctance to lower interest rates sooner has been lost on Indian government and corporate heavyweights.

India being a country of savers stands to lose if the real interest rates begin to disincentivise savings.

At about 6.5% the average real interest rate in India over the past 35 years has not been very high. The RBI's front loaded policy actions will therefore bear fruits only if...

  • The government backs it with meaningful reforms and flawless execution
  • Big ticket corporate capex acts act as a catalyst for GDP growth...thereby offering investors alternative means of fetching commensurate risk and inflation adjusted returns.

Tanushree Banerjee

Tanushree Banerjee (Research Analyst), is the editor of Stock Select and, ValuePro Equitymaster's oldest recommendation services. She is also the editor of Equitymaster's most popular newsletter read by over 300,000 subscribers, The 5 Minute WrapUp. Tanushree started her career at Equitymaster covering the banking and financial sector stocks and scrutinising RBI policies. Over the last decade, she developed Equitymaster's research processes that helped us pick out various multibaggers, across all sectors. A firm believer of "safety first" when it comes to investing, Tanushree closely follows the investing philosophies of Warren Buffett, Jeremy Grantham, and Joel Greenblatt.

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