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IMPACT OF RESERVE BANK OF INDIA REPO RATE AND OTHER ANNOUNCEMENTS

One of the main issues in managing a company today that recurrently poses challenges as well as opportunities for the firm – is Treasury Management. A major activity of Treasury Management is managing the working capital of a company, including raising funds from the money market at the lowest possible cost to finance working capital shortfalls. As a result, a careful study and continuous monitoring of the debt market, instruments of fund raising, rate movements per the Central Bank’s announcements, global macroeconomic updates – such as Federal Reserve and External Commercial Borrowings announcements, etc., become critical activities as part of the overall Treasury Management function. In many cases, strategic decisions made by a company are highly correlated to how management interprets these events, announcements, interest rate movements, et al.

RBI Announcements:

The Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) announced an increase in the key Repo Rate by 25 basis points to 6.25%, in a much-anticipated move, on June 6th, 2018. Simultaneously, the Reverse Repo Rate was adjusted to 6.0%, and the marginal standing facility (MSF) rate and the Bank Rate to 6.50%. This decision to hike the Repo Rate after 4 years, by the RBI, seemed like a carefully contemplated decision as a response to the recent inflationary pressures building up on the economy and the rising oil prices. Now, that a hike in the Repo Rate has been announced officially, banks too could be expected to start increasing their marginal cost-based lending rates (MCLR) soon.

Rationale:

Global economic activities have been expanding, particularly in advanced economies, while major macroeconomic developments in the emerging market economies (EMEs) remained largely pliant. Global trade growth continued to strengthen although geo-political tensions contributed recently to the declining export orders. With the US and China escalating their threats of tariffs on each other’s goods, a trade war has already started brewing up between the world’s two largest economies. While the US president, Donald Trump has announced plans to impose 25% tariffs on US$50 billion worth of Chinese imports, China has retaliated by imposing tariffs on US$50 billion of US products. On July 6th, the US and China are each scheduled to impose tariffs on $34 billion worth of imports from the other. Unless the two sides reach an agreement soon – a dangerous, long-lasting, escalating trade war may be under way. Such a trade war is likely to bring a whirlwind of uncertainty into the global economy. Besides, several other risks to inflation outlook persist; volatile crude oil prices have already increased India crude basket price sharply by 12% in April, which is earlier in the fiscal year than expected and likely to persist. Other factors that are likely to push headline inflation up include – uncertainty in global financial markets’ performance, the significant rise in household inflation expectations as revealed on May 2018 RBI’s round of survey and the staggered impact of house rent allowance (HRA) revisions by various State Governments.  Further, the probable impact of revisions in minimum support price (MSP) formula for Kharif crops which is yet to be seen and lastly, the Indian Meteorological Department’s (IMD’s) forecast of normal monsoon – may help keep inflation soft.

Impact:

The decision by MPC is unlikely to affect the short-term interest rate substantially. A greater impact maybe expected on long term interest rates in the country. The yield of a 10-year bond, that is considered a good indicator of the direction of long-term interest rates in the economy, witnessed an increase from 7.834% to 7.917%, immediately after the RBI announcement. However, there was a movement in the opposite direction for short-term interest rates resulting in a marginal decline.

While on one hand, the RBI has increased the Repo Rate, on the other hand, it has announced a reduction in the LCR (Liquidity Coverage Ratio) for the banks. It has now allowed 2% additional securities of the banks in high qualified liquid assets (HQLA) under Basel III calculations to be counted as part of statutory liquidity ratio (SLR). This means that banks would now have extra liquidity to lend to the customers. Therefore, while the long-term rates have moved upwards, the short-term rates have eased after this decision. Companies are using debt markets to raise working capital, wherein commercial papers (CPs) are offering lowest cost of borrowing with rates falling by approximately 17 basis points on average, for commercial papers with maturities of up to 9 months. The rates, as mentioned herein, drop further for CPs with shorter periods of maturity.

The immediate impact of the increase in Repo Rate may not necessarily get translated into higher deposit rates, as only very few banks such as State Bank of India and Axis Bank have hiked their deposit rates as of now; however, since this move was anticipated by lenders, the lending rates have already started rising steadily. This would effectively mean higher equated monthly instalments (EMIs) on home loans, car loans as well as personal loans.

Fixed deposits with long term tenures are likely to give better returns after the Repo Rate hike, as fixed deposit (FD) rates in India may rise marginally, provided that the global economic conditions remain somewhat similar and the crude oil prices do not witness a sharp reduction in the near future. Share prices in the Indian domestic stock markets have also experienced an increase, post the RBI announcement. This may be temporary as the markets may have had a knee-jerk bullish reaction to the more neutral stance of RBI as against an expected hawkish stance. There is a flight of foreign indirect investment (FII) from India but that can be interpreted as either for profit booking or for better alternative parking of money due to US growth and dollar strengthening, which is making the Indian market less attractive for the foreign investor. For example, in May 2018, net cash withdrawal by FIIs from the Indian markets were Rs 112.42 bn. However, domestic investors are still faithful to the Indian capital markets story, for example, Domestic Institutional Investors (AMCs, pensions funds in India) invested an incremental Rs 134.49 bn in the same month.

Conclusion:

If oil prices continue to rise, another hike may be expected in the Repo Rate by the MPC, most likely in the month of August. The MPC, in their official statement, noted that geo-political risks, global financial market volatility and the threat of trade protectionism pose headwinds to domestic recovery. Thus, in this light, it is important that public finances do not crowd out private sector investment activity and thus, adherence to budgetary targets by the Centre and the States will also considerably ease upside risks to the inflation outlook.

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Posted on : 23 October, 2018

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