RBI’S CREDIT POLICY – 2nd June 2015…

·         Repo Rate – The repo rate under the liquidity adjustment facility (LAF) has been cut by 25 bps to 7.25%.

·         Reverse repo rate & MSF – Consequently, the reverse repo rate under the LAF has been cut by 25 bps to 6.25% with marginal standing facility (MSF) rate and the Bank Rate at 8.25%.

·         Cash Reserve Ratio – The CRR of scheduled banks has been retained unchanged at 4.0% of their net demand and time liabilities (NDTL).

·         Statutory Liquidity Ratio – The SLR has been retained unchanged at 21.5% of their net demand and time liabilities (NDTL).

 

Key Takeaways from RBI policy

RBI has cut the repo rate by 25 bps to 7.25% in line with consensus estimate. This is the third rate cut in this year cumulating to the total of 75 bps cut. The rationale given by RBI for this rate cut was the i) low domestic capacity utilisation, ii) mixed indicators of recovery, and iii) subdued investment & credit growth. It felt that it was better to front load the rate cut. However, the policy statement was more on a hawkish side as CPI projected by RBI was raised from 5.8% to 6% by January 2016. RBI is cautious that inflation may again start inching higher post August as the base effect wanes off. Governor has categorically mentioned that it has front loaded this rate cut and future rate cuts shall be data dependent. RBI sounded cautious on future data on account of i) below average monsoon prediction by MET, ii) higher crude price and iii) volatility in external environment. RBI also expects the banks to pass on the benefit of this repo rate cut by lowering their base rate which is negative for banking sector.

 

Outlook  

Although RBI has cut the repo rate, majority of statements were hawkish in nature. RBI has projected CPI of 6% by January 2016 while it is targeting the real interest rate (difference between the CPI and repo rate) in the range of 1.5-2%. With repo rate at 7.25% now, we believe that CPI shall stay at 5.5% of sub 5.5% for further rate cuts. We believe that interest rate policy will be on a halt till September post which CPI data will be a crucial factor. RBI is in the process of building the framework for banks to use the marginal cost of funding for calculating their base rate. In current downward trending interest rate scenario, the marginal cost of funding method shall be negative for banking sector as the base rate revision is faster. While the benefit of lower cost of fund is accrued gradually over the period of time as deposits are re-priced but the adverse impact of lower base rate is immediate. One can use this correction as an opportunity to buy the good quality private sector banks and NBFCs having steady earnings growth trajectory. Our preferred picks include Yes Bank, Indusind Bank, ICICI Bank, HDFC Bank, HDFC Ltd and Dewan Housing Finance.

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