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Posted on 17-Mar-2017 Comments  0

RBI Rate Cuts


It looks unlikely, at least, till Junethis year…



A day after the inflation data and the US Fed announcement, the big question reverted back to the RBI stance. The primary question was once again the same; will the RBI cut repo rates in its April 2017 monetary review. Here are 4 reasons why the RBI will not…


Remember the MPC minutes…


The Feb MPC minutes were quite revealing in that the committee had recommended shift in the monetary policy stance from “Accommodative”to “Neutral”. As the RBI governor put it, it leaves the option open to the RBI to move the rates either way. It indicates that the era of consistent downward trending rates is over in India. Markets need to be mentally prepared for that. A rate cut in April 2017 is almost as good as ruled out, at least as of now!


Fed has hiked rates…


The Fed decision to hike rates by 25 basis points was largely expected.But the RBI will be watching out for the trajectory more closely. The Fed has hinted at 2 rate hikes of 25 bps each, which will take the Fed Funds rate to 1.50%. That is what even the Fed Fund Futures are implying. However, these conditions could change quite fast. If inflation picks up or growth spurts, then the Fed may increase the pace. In that event, the RBI would not want to be in a situation wherein it is left with little rate differential to stem FPI outflows.

Inflation is creeping up…


That could be the bigger worry for the RBI when it comes to rate action.The CPI inflation has crept up to 3.65% while the WPI inflation has crept up to 6.55%. Non-core inflation continues to be sticky and the food inflation has also showed signs of picking up. With the El Nino effect likely to afflict the weather in South East Asia this year, we may have a sub-par monsoon and a weaker Kharif output. Under these circumstances, the food inflation could put persistent pressure on overall inflation. The WPI has shown some real pressure coming from higher fuel prices and stronger price of minerals and ores. If inflation consistently goes up, then the RBI will have little room to cut rates. An element of clarity will emerge only after the first official meteorological estimates come out. The RBI may choose toplay it safe, at least, till that time.


What does rate stance look like?


While April rate cut is almost ruled out by the RBI, even June rate cut is highly doubtful. Post June, it will depend on the inflation and monsoon data as well as how the Fed stance pans out. The bigger takeaway for the financial markets is that Emerging markets including India may be close to a bottom on rates. That leaves the rate action open on both sides. The focus will be on growth with inflation,rather than no-growth with no-inflation!


FPI Inflows


Why they could now make a serious comeback…



Between October 2016 and January 2017, Indian markets saw FPI outflows to the tune of Rs.80,000 crore ($12 billion). These outflows were driven bythe fears of demonetization and the expectation of a Fed rate hike.FPIs were also worried about corporate numbers. All that looks set to change…


There is a return of FPI flows…


In the last 10 sessions since the beginning of the month of March, the FPIs have infused nearly $1.5 billion into Indian equities. Of course, this fades when compared to the $12 billion that had earlier moved out of India. But then the trend towards inflows is evident.With most of the uncertainty behind us, the FPIs may have the left-out feeling. This may be the beginning of the trend of FPI flows returning into risk-on economies like India.


Political continuity is the key…


One thing that will surely gratify the FPIs is the decisive win that the BJP recorded in the crucial UP elections. It was almost seen as a mandate on demonetization. What the result has revealed is that people are more than willing to support the government on genuine reforms that will make a difference to them. That should propel the government to make a move on sensitive legislations like the Bad Bank, labor reforms and land reforms. For FPIs the reforms process is now irreversible!


Limited risk of US hawkishness…


To be fair, the US Fed has been hawkish in that it has guided two more rate hikes in the calendar year. However, that was largely factored in. With the RBI likely to maintain status quo on rates, at least till June, the rate differential will not be a great concern for the RBI. Also, FPIs will now be convinced that the tail risk of any future US rate hike is unlikely to be as bad as it was in the aftermath of December 2015. FPIs also strongly believe that the US hawkishness on rates will be largely tempered when spending is triggered off by tax cuts and an investment cycle is triggered by infrastructure spending. With a clearer trajectory on Fed rate action, the FPIs will look at more risk-on opportunities to add alphato their portfolios. This may just be the beginning.


FPI rupee bets went wrong…


Most FPIs are getting the left-out feeling. Between November and March,Indian markets have rallied sharply and most FPI have missed the bus.The reason is that their bet on the rupee went sorely wrong. The normal bet was that the INR would weaken further to 72/$, which led to the selling. The idea was to enter the Indian market at 72/$ level to play the stock appreciation as well as the INR. With the INR coming back to 65.5/$, there is likely to be a rush of FPIs into India. This could be the big trigger for Indian markets!


Crude Oil Prices


Where exactly is crude oil prices headed from here?



The price of crude has had a volatile period since the beginning of 2016.After touching a low of around $30/bbl in early 2016, crude bounced back sharply to almost the $45 level. It was only post November that Brent Crude actually breached the $50 mark decisively and perched closer to the $56 mark. However, over the last few days, the price of Brent is back to around the $50 mark. Where exactly is Brent headed and what could determine the road ahead for crude?


OPEC will play a bigger role…


The big surge in crude oil came after November 30th when the OPEC decided to voluntarily cut supply. While the OPEC agreed to cut daily supply by 1.2 million barrels, friendly non-OPEC nations like Russia and Mexico agreed to cut output by 0.6 million barrels. This resulted in a total cut of 1.8 million barrels per day(bpd). Interestingly, the effect of the production cut on actual Brent supply and price will be only visible from this month onwards.One thing is clear that the OPEC still has the power to influence prices and that is something the OPEC will not want to cede easily.Hence the oil supply quotas may continue. The big worry was that the 6-month quota agreement expires in June. For now, it looks like the OPEC will continue with its quotas and other friendly nations will be willing to support the same. At least, it has served to stabilize crude oil prices for now!


US may not play spoilsport…


One of the worries for the OPEC was that a rise in oil prices will enable many of the inactive US shale wells to become viable once again. That has definitely happened in the recent past as the Baker Hughes index has indicated a consistent addition to the number of rigs in operation in the US. Additionally, shale extraction is one of the key thrust areas for Donald Trump. He not only plans to incentivize shale further but also wants to allot more national land for shale extraction. For the US to handle such a vast increase in supply, it will need a robust market across the world. Historically robust demand and spending has been seen across the world only when oil has been at elevated levels. Low oil prices have been periods of economic strife and deflation. That will defeat the entire American purpose.Surprising at it may sound; the US may also tacitly help the OPEC and Russia in keeping crude oil prices at remunerative levels in the future.


Where does that leave oil prices?


Even with a large dose of optimism, the oil prices are unlikely to see the levels of $100/bbl any time soon. That is unlikely with so much supply in the sidelines. What could happen is that the oil could stabilize in the range of $50-60/bbl with the potential to briefly get closer to the $70 mark. Supply at $70 will be just too huge to sustain. Time for firm oil!


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