RBI keeps key rates unchanged; sets external benchmark for loansAs anticipated by the markets, Reserve Bank of India has kept the key policy rates unchanged while it continued with its earlier stance of “calibrated tightening”.

In its fifth bimonthly meeting of the six-member Monetary Policy Committee (MPC) held this week, the decision of which was announced on December 5, the committee has unanimously voted in favour of a pause in repo rate to keep it at 6.5%. The repo rate is the rate at which the RBI lends to other banks in India.

While five of the six-member MPC led by RBI governor Urjit Patel voted to retain the stance as “calibrated tightening”, Ravindra H Dholakia, a member, voted to change the stance to neutral.

RBI has also cut its inflation forecast for the rest of the financial year, citing a sharp fall in crude oil prices and food “deflation”. It has forecast inflation to fall to 2.7-3.2% from 3.9-4.5% for the second half of the current financial year.

RBI Key rates December 2018

What it means for you

RBI has not indicated any hawkish or dovish bias in its policy statement. It also reiterated that it remains data driven for any future policy decisions. Thus, if the inflation continues to remain benign and growth continues its trajectory to meet RBI projections we may see RBI going on a long pause in terms of key interest rates. This primarily means the lending rates in the economy could potentially stay where they are for next couple of quarters.

New external benchmark for loans

In another key decision, RBI has proposed to introduce new external benchmark for home, auto and micro and small enterprises loans from 1st April 2019. RBI has also asked banks to keep their spread (the difference in borrowing and lending rates of financial institutions) fixed over the benchmark rate throughout the tenure of the loan.

“This will possibly stop floating rate customer being cheated by banks in future,” according to an article in personal finance magazine MoneyLife. Apparently, floating rate customers have been taken for a ride by banks as the rates are increased by banks when the RBI hikes key policy rates, but do not bring it down when the rates go down.

The external benchmark now proposed by RBI includes its policy repo rate, government of India 91 days treasury bill yield produced by the Financial Benchmarks India Pvt Ltd (FBIL), government of India 182 days treasury bill yield produced by the FBIL, or any other benchmark market interest rate produced by the FBIL.

RBI said in the statement, “The spread over the benchmark rate — to be decided wholly at banks’ discretion at the inception of the loan — should remain unchanged through the life of the loan, unless the borrower’s credit assessment undergoes a substantial change and as agreed upon in the loan contract.”

RBI said, “In order to ensure transparency, standardisation, and ease of understanding of loan products by borrowers, a bank must adopt a uniform external benchmark within a loan category; in other words, the adoption of multiple benchmarks by the same bank is not allowed within a loan category. The final guidelines will be issued by the end of December 2018.”

This is a positive move for borrowers as they will get the benefit of external interest rate movement set by RBI without banks’ discretion in setting the rates for the floating rate borrowers.

Bond yields come down

Coming to bond yield movement, following the policy announcement, G-sec on Wednesday lost around 13 bps to close at 7.44 from the previous close of 7.573%. Over the past couple of weeks G-sec yields have cooled off significantly. However owing to liquidity issues and stress in NBFC space the corporate bond yields are still at elevated levels. As the situation improves and RBI remains on pause we may see these corporate bond yields also coming down.

Investors may benefit out of this opportunity by taking exposure to categories like low duration funds, ultra short term fund and corporate bond funds with lower modified duration. Such exposure will help investors to make most of the opportunity and ride over volatility in case the expected scenario does not play out.

The other key observations by RBI in its policy statement

Global Economy: Global economy has shown signs of weakness owing to trade tensions. Since the policy meeting in October 2018, growth in Advanced Economies (AEs) like US, EU & Japan slowed down. The theme continued in emerging markets as well, major developing economies like China and Russia lost growth momentum. The inflation has risen globally and bond yield have also softened in recent weeks.

Domestic Economy: Domestically, the Gross Domestic Product (GDP) declined to 7.1% in June-Sept quarter. This decline in GDP is attributed to moderation in private consumption and lower net exports. The statement further says “Growth in the index of industrial production (IIP) slowed down to 4.5 per cent in September 2018. Capacity utilisation (CU), increased from 73.8 per cent in Q1 to 76.1 per cent in Q2, which was higher than the long-term average of 74.9 per cent. The purchasing managers’ index (PMI) for manufacturing touched an eleven-month high of 54.0.” Consumer Price Index (CPI) undershot RBI’s projections and stood at 3.1% owing to softer food inflation.

Liquidity: There was large amount of currency in circulation in October; especially during festival season in November. However this liquidity dried up in the latter three weeks of November month.

FDI flows moderated till September in this financial year as the sentiment was dented by high oil prices. November onwards we are starting to see increasing inflow. However net portfolio outflow stands at USD14.8bn.

As per RBI’s statement, “India’s foreign exchange reserves were at US$ 393.7 billion on November 30, 2018”.

Outlook on Inflation and Growth: RBI lowered CPI inflation projection from 3.8-4.5% to 2.7-3.2%. The policy statement mentioned, “The broad-based weakening of food prices imparts downward bias to the headline inflation trajectory, going forward.” Food inflation contributes~50% of the CPI inflation. This is the lowest inflation projection RBI has given since the central bank started inflation targeting.

The GDP growth projections were maintained at 7.4% for the year. Lower crude oil prices, improved credit off take and business activity are positives for the growth while lower rural demand (driven by lower rabi sowing), financial market volatility, global tensions and slowing global demand pose a threat to the growth.

 

Author
Priyanka Bharati

Priyanka Bharati is a senior personal finance analyst with RupeeIQ. She can be reached on priyanka.bharati@rupeeiq.com