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BIG NEWS ON 7TH DECEMBER 2018


Posted on 07-Dec-2018 Comments  0

Monetary Policy

The RBI is still playing it safe and keeping its options open

The monetary policy announced on 05th December was largely along expected lines. A lot has been said about the repo rates but that was held at 6.50% along expected lines. This ensured that the reverse repo rate stayed at 6.25% while the bank rate stayed at 6.75%. While the policy has downsized its inflation expectations for the next few months, it still believes that the inflation risk is elevated due to oil price uncertainty. Also, the RBI is of the view that the full impact of food inflation may not be visible as yet. Now for the 3 issues… 

Why calibrated tightening

With a sharp fall in inflation, the markets were expecting a shift in the monetary stance from “Calibrated Tightening” to Neutral. However, the MPC voted 5:1 in favor of retaining the monetary stance. The RBI has been driven by two factors. Firstly, the policy meeting came just a day ahead of the OPEC meet, which was to decide on supply cuts by the OPEC and friendly nations. MPC expected any cut of more than 1 million bpd to impact prices of crude oil. Secondly, the rupee was yet to stabilize. CAD has come in at a multi-year high of 2.9% and that would make the rupee a lot more vulnerable. RBI may have to hike interest rates to check the rupee fall. Lastly, the Fed has only hinted at a dovish shift but December Fed meet could hold the key. The RBI may look to change the stance at a later date but has opted to stay hawkish.


Liquidity issues addressed

There was the big expectation that the RBI would focus extensively on liquidity considering the huge shortfall in the financial markets. The RBI has been pumping Rs.40,000 crore per month into the financial markets and has promised to keep the taps flowing. In addition, the banks have also agreed to keep the liquidity taps open so that the NBFC sector does not suffer in delivering the last mile. Towards that effect, the RBI has also continued with its SLR cut. Effective January 2019, the SLR will be cut in 6 tranches of 25 bps each from the current level of 19.5% to 18%. This will technically ease liquidity in the banking system but the big question is whether it will push more lending since banks are already holding excess SLR.

Going beyond the MCLR

One of the big announcements in the policy was the decision to benchmark all retail and MSME loans to an external benchmark like the T-Bill yields. Currently, loans are benchmarked to the MCLR and that is often not linked to the market reality. But there are practical problems. Firstly, how do you follow market benchmarks when your loans are not exactly market driven? Secondly, the spread over the benchmark is still subject to banker discretion. Lastly, these things have been tried in the past and found to be impractical. It is MCLR that works best in these cases!


US Yield Curve

Indian markets should worry about the inverted US Yield Curve

In the last few months, Indian analysts and economists have spent a lot of time and ink worrying about the likely effects of a full-fledged trade war. Trade war is not even helping the US so it is unlikely to help any other country. Obviously, a trade war will lead to a slowdown in exports and a consequent slowdown in overall economic growth. Both the IMF and the World Bank have projected an impact of 30 to 40 bps due to the trade war. But that is not the immediate worry for India. What is happening on the yield curve is a lot more important. Here is why.

What is the yield curve?

Before we talk about an inverted yield curve, let us step back and first see what this yield curve is all about. Yield curve plots the yield on benchmark debt instruments of different tenures that are issued by the government. Under normal conditions, the yield curve has a positive slope because the longer the tenure, the higher the yields. Risk increases with time and that makes yields dearer. A 10 year bond must command a higher yield than a 5 year bond, which must in turn command a higher yield than a 2 year bond. That is the way the yield curve works. But there are those odd occasions when the yield curve turns inverted. That means; the long term yields fall below the shorter term yields. That is exactly what is visible in the US at this point of time. Let us first understand why this inversion of yield curve is critical.

An inverted yield curve

In the last few weeks, the US yield curve has turned inverted for the first time in the last 10 years. An inverted yield curve means that the yields on the longer term bonds are lower than the yields on the shorter tenure bonds. This situation normally occurs when there is tremendous uncertainty over the future and hence investors prefer to stay at the short end of the yield curve. In the past, such situations have been indicative of a forthcoming recession as a negative slope of the yield has served as a lead indicator. In 1998, the yield curve became inverted and exactly in 2 years by the end of 2000 the US economy had slipped into recession. Again in 2005, the yield curve was inverted and this was followed by a recession from late 2007 onwards. Watch out for that!

What it means for India?

For the Indian economy, it could have important implications. Firstly, an impending recession could mean that the Fed will not be too keen to hike rates and that will reduce the pressure on the RBI. But a weak US markets has never been good news for emerging markets like India. Sectors like IT and pharma do rely on US demand and India’s GDP growth has normally benefited from positive US cues. Above all, weak US growth could mean deflation of asset values and that could be the big worry. For a rally built on liquidity, that is not good news!


OPEC Cuts Supply

OPEC is back to supply controls, but will it be effective

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Source: Oil & Gas Journal


The OPEC meeting on December 06th and 07th finally agreed upon the quantum of supply cuts. The total supply cut would be to the tune of 1.20 million bpd. Out of the cut, OPEC would contribute 8 lakh barrels while Russia, Mexico and other would contribute 40 lakh barrels. This is higher than the 1 million bpd originally estimated. What would be the impact of this move?

Price impact was visible

In the immediate aftermath of the move, the price of Brent crude shot up by 6%. The demand for crude has crossed 100 million bpd for the first time and this move to cut production by 1.2 million bpd should be instrumental in limiting the price damage from current levels. What this does to their relations with the US remains to be seen but for now the demand gap over supply of crude will be reinforced. The price damage may have been averted but it remains to be seen if prices sustain.

Demand could hold the key

The real concern would be whether the demand would hold. Currently, the demand for oil is high due to winter demand, which normally leads to strong heating oil demand from Europe and the US. The bigger concern would be the likely slowdown. The trade truce between the US and China may have hit a roadblock after the recent arrest of the Huawei CFO. Trade wars have been definitely doing the damage in China as it has been leading to a fall in consumer demand. Auto stocks worldwide have been under pressure due to higher oil prices and that could impact the price of oil. Also, if the trade war leads to a growth slowdown by 30-40 bps, as estimated by the IMF, then the impact on oil demand could be quite acute. Crude demand could also go down due to higher ethanol blending by countries like India. If demand peters, supply cuts may not really be effective. A lot would depend on post-winter demand!



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