Raghuram Rajan, the governor of the Reserve Bank of India, surprised markets this week by cutting the repo rate by 50 basis points to 6.75%. The RBI described the move as a “front-loaded policy action” and, given its inflation projections, this “ensures one year expected Treasury bill real interest rates of about 1.5-2.0 per cent, which are appropriate for this stage of the recovery.” Before Tuesday’s move, the RBI had already cut interest rates 3 times by a total of 75 basis points since January, although some of the problem has been weak transmission to the economy as the banks have only lowered their median lending rates by ~30 basis points. With this cut came a clear statement; “while the RBI’s stance will continue to be accommodative, the focus of monetary action for the near term will shift to working with the Government to ensure that impediments to banks passing the bulk of the cumulative 125 basis points cut in the policy rate are removed.”
Most economists had expected a cut of 25 basis points at most. But the RBI noted that since its last review “the bulk of our conditions for further accommodation have been met.” Most notably this reflects inflation which has dropped to a 9 month low despite the ‘monsoon deficiency’ reflecting “resolution actions by the government to manage supply”. Thus, with “the January 2016 target of 6 per cent inflation is likely to be achieved… the focus should now shift to bringing inflation to around 5 per cent by the end of fiscal 2016-17. In this context, the weakening of global activity since our last review suggests that commodity prices will remain contained for a while. Still-low industrial capacity utilisation indicates more domestic demand is needed to substitute for weakening global demand in order that the domestic investment cycle picks up.” A more accommodative stance of 50 basis points should boost confidence more and help investment recover.
The RBI has marginally downgraded its growth forecast for the fiscal year ending March 2016 to 7.4% from 7.6%. But India’s much better positioning than many emerging markets is reflected in the currency performance rankings which show the rupee down ~4.1% year to date. India’s foreign exchange reserves rose USD10.4bn in 1H FY 2015-2016, the current account deficit is expected to be ~1.5% of GDP in the current fiscal year and the government is focused on meeting its fiscal deficit target of 3.9% of GDP. Estimates from fDi Markets show India attracted over USD30bn in foreign direct investment in 1H 2015 exceeding even China.
India is also one of the better positioned emerging markets having low levels of foreign sovereign debt ownership; the RBI has also announced its intention to increase the cap on foreign institutions’ holding to 5% of outstanding government debt by March 2018. The limit for investment in State Development Loans will also be increased to 2% of outstanding stock. The RBI estimates that this will allow an additional USD25 bn in investment in central and state government securities by March 2018. Thus, India is in a different position to markets such as Indonesia and Malaysia where foreigners own ~35% of the sovereign bond market.
On our NFA estimates for 2011 India has net foreign liabilities of 34.5% of GDP which is comfortably within our cut-off of net foreign liabilities of 50% of GDP. The issue with India remains, in the absence of a rating upgrade, the lack of ‘cheap’ bonds in our USD Eurobond universe.