The Reserve Bank of India (RBI) has cut interest rates by 50 basis points from 7.25% to 6.75%, far more than the 25 basis points market commentators had expected.
Governor Raghuram Rajan cited the slowdown in China and weakening global demand as reasons for the cut, which was the fourth one the RBI had undertaken in 2015 .
Two leading equity manager specialising in the region have given their views on the policy moves and what longer-term impacts it might have on the Indian economy.
Indian putting tools to work
Citywire AA-rated Kunal Desai, who is head of Indian equities at Neptune Investment Management, believes the rate cycle is following inflation data which is trending downwards.
RBI Governor Rajan has revealed that their definition of real rates has changed to the one year T-bill minus inflation. He mentioned that 1.5-2% real rates would be desirable. One year T-bill rates typically quote 25 basis points above the headline interest rate and real rates sit above target at 3.6%. This means that from a rate cutting perspective there is more to go.
Secondly, the RBI announced a much larger than expected expansion of limits for foreign investment in Indian bonds. This amounts to a 5% increase of the outstanding stock and should translate to roughly $25 billion over the next 30 months. These measures further open up and deepen the bond market, which is a big positive.
As we have been arguing over the past few months, we expect India to diverge from other emerging markets and continue on its monetary loosening agenda. The government and RBI have worked hard together to iron out a number of frailties from an external vulnerability perspective.
The current account and fiscal deficits are under control, inflation continues to fall, growth is accelerating and lower crude prices continue to support the rupee.
The Reserve Bank of India may have cut its benchmark interest rate by 50 basis points to 6.75%, but a tame inflation outlook suggests there is room for a further 50 to 75 basis point cut in the next six to nine months.
With consumer price inflation running at 3.7% in August, the RBI, in our view, is unlikely to meet its aim, under its inflation-targeting regime, of achieving 6% inflation by January 2016.
The RBI also took a number of other measures we believe will provide a boost to the Indian economy by increasing the availability of credit. The decision to cut the statutory liquidity ratio (SLR) – the amount of money that banks have to hold in the form of government bonds – is a welcome move.
The RBI has cut the SLR by one full percentage point, which will be staggered over four quarters. Although the cut is academic because the average Indian bank already has 500 basis points of excess SLR on their books, it does represent a clear signal from the RBI that it wants to Indian banks to increase their lending.
A second measure to allow foreigners to buy up to 5% of total outstanding rupee-denominated federal government bonds, up from 3.8% should also provide further stimulus to the economy as investors are likely to be attracted to the higher yields they can obtain in India relative to other emerging markets.
Finally, those Indian companies, which have the ability to borrow money abroad, will now be able to issue bonds in rupees rather than exclusively in foreign currencies. These so-called ‘Masala bonds’, aimed primarily at foreign investors, could provide a useful additional source of funding for Indian companies.