Decoding RBI monetary policy to be announced on 07 December 2016

Three days after demonetization on 08 November 2016, RBI had come with a measure to suck out liquidity from banks. There had been a deluge of deposits in banking system which is likely to gain further momentum till 31st December 2016. There is a limitation of total sterilisation by RBI (about 700k) in reverse repo (linked by total stock of Gsec/Oil bonds). This is a short term measure and will be revisited in the next fortnight cycle.

This temporary CRR hike is expected to take near 330k of banking liquidity out. Currently the system is sitting on approximately 700k excess liquidity, thus banking system will remain flush with excess liquidity even after this move. This move actually helps RBI to manage liquidity in absence of which overnight markets would have gotten completely dislocated (as RBI couldn’t haven’t absorbed the rise of excess liquidity).

It hurts banks as on such a large amount (330k), banks don’t get paid. It has some unique consequences on rates. Banks are likely to reduce fixed deposit rates even more sharply (because they earn zero on all incremental deposits, so why should they pay even 6% on 1 year FD, is how they will think) and thus it’s likely that investors chase non-bank saving instruments even more.

What happens to rates? It’s likely that first order impact of this move is negative as some participants may read it a standard CRR hike (which it is not), but in reality it’s far better than other situation that market could have faced (Large MSS issuance)!

Demonetisation has opened up space for steep rate cuts. What lies ahead is huge disinflation (3% in Nov/Dec), growth shock (3-5% cut in GDP in Q3) due to liquidity crunch and wealth shock (20-25% of India’s wealth evaporated over last 25 days across realty index, stocks and bonds) thus sharp rate cuts (our base case remains 5.25% Repo).

Let’s wait for tomorrow, 07 December 2016, to seek the RBI’s monetary policy!

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