The value of the Rupee: update as of April 2016

RBI Watch                                                                                      Indian Rupee

Please also read my April 25, 2014 blog titled "Is the Rupee fairly valued?".

                                                                                                                                                                   

The flow of money in 2015-16: what do the numbers tell us?

Money flow measures - deposits, credit, money supply and reserve money – grew at historically low rates in 2015-16, although there was a good pick-up in credit. Looking at these measures in real terms – after stripping out inflation - the picture is positive. In real terms these measures grew at the highest pace since 2009-10. This suggests an improvement in India’s economic prospects could be expected in 2016-17 – perhaps with a small  pleasant surprise if the international environment remains stable.

This is an update of my earlier blog on February 16, 2016.  Below are the numbers covering growth of bank deposits and credit, money supply and reserve money for the last financial year, 2015-16.

Deposits and Credit Growth

Deposits grew by just 10 % in 2015-16, the slowest pace of growth since the start of India's economic reforms in 1991.

The pace of credit growth picked up but was also low looking at the period since 1990-91. Notably it outstripped deposit growth for the first time since 2011-12. This should be positive – suggesting that there is more investment beginning to take place.

Let’s look at the real growth in deposits and credit – i.e. the growth of deposits and credit after stripping out inflation. For judging the level of inflation, I have taken the GNP deflator (the difference between the country’s national product in current prices and constant prices) instead of consumer price inflation or wholesale price inflation. This appears more suitable as it captures the prices paid by all economic agents - consumers and producers.

The table below gives the real growth in credit and deposits since 1990-91.

  

In real terms, the picture of deposits growth is better – in 2015-16, deposits grew at the fastest pace since 2009-10. Note during 2003-08 period, when India grew at 9% per year, deposits grew at 14% per year!

The picture on credit growth also looks better in real terms. In 2015-16, credit grew at the fastest pace since 2010-11. Again, note during the high growth period of 2003-08, credit grew by 20% per year!

 Money Supply and Reserve Money Growth

With the dip last year, the growth in money supply seen last year was the lowest since 2001-02.

As the year drew to a close, reserve money growth picked up and grew faster than last year, but like all the other numbers above remained low, looking at the period from 2001-02.

The table below shows the real growth in money supply and reserve money since2001-02. The numbers have been calculated just as I calculated the real growth in deposits and credit – after stripping out inflation.

 In 2015-16, money supply in real terms grew at the fastest pace since 2009-10, but far less than the 13.5% number registered during the high growth period of the economy during 2003-08. The picture is quite the same when we look at reserve money growth – fastest growth since 2010-11, but significantly lower than the 13.5% clocked during 2003-08.

Money is arguably the engine that spurs the economy forward. These numbers suggest that an increase in the growth of India's economy can perhaps be expected this year (2016-17), but the increase is likely to be modest.

The government’s Economic Survey expects growth between 7.25 and 7.75% in 2016-17 –the mid-point of this range is just about the same as the 7.6% estimate of the government last year. The RBI expects the economy to grow by 7.6% in 2016-17, a tad higher than its estimate of growth of last year of 7.3%.

My sense is the growth number could be a little better than expected, if international environment remains stable. Here China’s performance is a key contributing factor, as I have emphasised in many of my earlier blogs.

Rupee has fallen both in nominal and real terms against a basket of currencies in 2015-16

But if you consider the last two years, then the Rupee has risen 

 RBI Watch                                                                                               Indian Rupee

The tables below give the performance of the Rupee against a basket of currencies both in nominal and real terms for the last one year, and also for the last two years.

To get a flavour of what transpired over the last one year, please also see my blogs of December 18, 2015 and September 15, 2015.

 The bottom line is the following:

The Rupee is overvalued in real terms, but over the last one year the overvaluation has moderated.  In real terms the Rupee fell by 1.36%.

The RBI has contributed to a more competitive Rupee – by buying U.S. Dollars and selling Rupees in the interbank market as part of its fx intervention. This it has been confident of doing as inflation has trended down, and providing liquidity to the Indian market made sense, as part of an accommodating monetary policy to support growth of the economy.

To get another perspective, let’s look at the picture over the last two years. The picture is different: in real terms the Rupee has strengthened by about 7%. This is significant.

The message is clear: under present circumstances the RBI could well contribute to a more competitive Rupee by continuing to buy U.S. Dollars and selling Rupees. This is consistent with the macro context: RBI expects inflation to fall further, even as a continued acceleration in growth requires more liquidity in the Indian market.

RBI’s interventions are primarily against the U.S. Dollar. This would suggest a weaker Rupee against the U.S. Dollar in the coming year. But this calculation could be over turned if capital inflows are so great that the RBI is forced to prevent the Rupee from appreciating, in which case the Rupee may see not much change against the U.S. Dollar this year, 2016-17.

When could this occur?  Here are three possible scenarios: India’s growth picks up far greater than expected, Federal Reserve puts interest rate increases on hold, and China solves its macro problems smoothly.

The numbers below give the performance of the Rupee against the four major currencies - the U.S. Dollar, Pound Sterling, Japanese Yen and the Euro.

During the last year, the rupee fell against all the four currencies, more so against the Euro and Yen. However, over the last two years the Rupee fell only against the Dollar, strengthened against the pound and euro, and remained stable against the Yen.

Indian Stock Market Watch: Margin funding of investors by brokers continues to be weak

Margin trading by investors on the NSE - an update as of March 31, 2016

Please see my blogs dated October 19, 2015 and July 22, 2015. Below are the updated numbers as of March 31, 2016.

Repo rate cut by 0.25% : RBI and Government walk in step

First Bi-Monthly Monetary Policy Statement on April 5, 2016 by Governor Rajan 

Repo rate cut by 0.25%, but borrowing rates for end customers to come down more as a result of past measures. Long term finance, wholesale and custodian banks may see the light of day

Monetary Policy                                                                                                     2016-17

Governor Rajan announced a 0.25% cut in the key policy rate, the repo rate. With this the fixed rate at which banks borrow from the RBI comes down to 6.5%.

The RBI’s outlook on inflation sees no change from its earlier version in the last financial year: 5% CPI inflation by the end of the current financial year, 2016-17. My view expressed in my blog on April 1, 2016 was that under these circumstances the RBI should not reduce the repo rate at the April statement date, but should do so at the June or August statement dates after the picture on inflation became clearer, and the pass through of rate cuts by the RBI in the last financial year – altogether 1.25% - via banks to the end customer become stronger.

My view is that the RBI has complied with the government’s desire, which was made public by the Finance Minister himself two days before the April 5 statement.  In fact, the RBI itself makes the point that the rate cut is not really significant. This is what the monetary policy statement says very sensibly:

“Perhaps more important at this juncture is to ensure that current and past policy rate cuts transmit to lending rates. The reduction in small savings rates announced in March 2016, the substantial refinements in the liquidity management framework announced in this policy review and the introduction of the marginal cost of funds based lending rate (MCLR) should improve transmission and magnify the effects of the current policy rate cut. The stance of monetary policy will remain accommodative.”

In my April 1 blog, I had brought attention to the cut in small savings rates and the introduction of MCLR – these measures themselves will lead to further monetary easing feeding through to the end customer. In addition the RBI has introduced new measures to ease the mechanics and volume of its lending to banks via the repo rate. As these are quite technical, I will go into these in a separate blog, but the bottom line is that it looks like banks will typically be getting more short term liquidity from the RBI in the future.

Now what? I had indicated that 0.5% cut in the repo rate could well be expected in 2016-17. So another 0.25% cut in the repo is on the cards, assuming RBI’s inflation outlook for the year materialises.

The monetary policy statement contained one significant regulatory development: the RBI is continuing with its policy of issuing differentiated bank licenses. Last year saw the licensing of small finance and payment banks. This financial year the RBI is considering licenses for long term finance, wholesale and custodian banks. This is a welcome development.

In the conference call with media, Governor Rajan also stated that the on-tap licensing of universal banks will come into effect. This is another welcome development.

Will margin funded investors get it right on Suzlon this time? An update as of March 31, 2016

Indian Stock Market Watch

Please see my earlier blogs on Suzlon ( October 19, 2015 and July 22, 2015). Below are the updated numbers as of March 31, 2016 covering the last six months.

Suzlon's position among the top five companies funded by margin has risen to second from fifth six months ago; at the same time, the level of margin funding has also risen to Rs 2 crores from 1.3 crores.

Yet Suzlon's share price has come off sharply by about 30%. Are margin funded investors too bullish on Suzlon?

RBI Governor’s April 5, 2016 monetary policy statement: RBI should keep rates on hold

From today bank loans based on marginal costs of funds and a lower small savings rates on government schemes come into effect – this by itself may lead to further monetary easing

Monetary Policy                                                                                                     2016-17

In my earlier blogs, October 8, 2015 and December 11, 2015, I had said that I do not expect the RBI to reduce the key policy rate – the repo rate – till the new financial year 2016-17. This time I was right – rates have been on hold since Sept 2015.

I also suggested that the RBI could reduce the policy rate by at best 0.5% in 2016-17.

We are now into the new financial year and Governor Rajan’s monetary policy statement is due in a few days. What should we expect from the RBI?

My view is that the RBI should make no change in the repo rate, currently set at 6.75%.

Over the last twelve months, inflation has followed the path the RBI expected. February’s reading of CPI inflation came in at 5.2%; this suggests that the March number due to be released later this month  will likely indicate inflation below 6% for 2015-16.

RBI expects inflation to move lower to 5% by the end of the current financial year, 2016-17. At 6.75%, the repo rate builds in a real interest rate of 1.5 to 2%. This is RBI’s target. Hence my view that the repo rate should be kept on hold.

The disinflationary bias continues in the world – recent estimates of world growth have seen a downward revision. The world economy is expected to grow about half a percent below its trend rate. Commodity prices are low by historical standards.

India’s budget focuses on rural, social and infrastructure spending; incremental reforms have taken precedence over high visibility structural reforms. There is no relaxation in the central budget deficit target of 3.5 of GDP, although many observers have raised question marks over the maths behind the budget numbers, and the fact that some numbers appear to be off-budget.

In this context, it will be interesting to see the path of inflation that RBI sets out in its monetary policy statement to be released on April 5. My view is as the financial year unfolds if the actual trajectory of inflation turns out to be in line or better (lower) than the RBI’s expected path, then a case can be made to reduce the repo rate. Or there must be strong grounds for the RBI to believe that this will be so.

One key factor to consider is how bountiful this year’s monsoon will be. Rain in January and February has been below normal. Reports suggest water scarcity in some parts of India during the current sowing season. I believe estimates by the IMD on the extent of rainfall during the monsoon season will be first released in April. It would be appropriate for the RBI to take this factor also into account before considering any change in the repo rate. So I believe the RBI should not change the repo rate till its second  bi-monthly monetary policy statement, which should be in June.

RBI has been attempting to improve the pass through of its accommodating monetary policy stance to the end customer - small businesses, corporates and home buyers – without much success. RBI has cut the rate at which it lends to banks, the repo rate, by 1.25% since January last year. Banks in turn reduced deposit rates, but did not reduce their lending rates commensurately.  Governor Rajan has on many occasions exhorted banks to pass on more of the reduction in deposit rates to borrowers, but bankers did not heed his advice.

Finally, the RBI late last year issued a diktat to banks: effective today, banks will have to price new loans based on the marginal cost of funds (MCLR). The RBI needs to watch the MCLR of banks for some time to see whether banks reduce their lending rates in the current financial year.  If banks do respond, further monetary easing will have taken place. This is another reason why RBI should keep the repo rate on hold.

Another attempt to improve the pass through of its accommodating monetary policy stance to the end customer - small businesses, corporates and home buyers – was to get the government to align small savings rates to market rates. Government has acceded to the request of the RBI: two weeks ago the government reduced rates on various small savings schemes by 0.5% to 1%, and announced that in future rates would be reset every quarter. This is a sensible development which comes into effect today.

Here again, the RBI needs to watch how banks respond to the closer integration of the small savings schemes of the government with the larger market for bank deposits, and see whether the expectation that banks will now reduce their deposit and lending rates materialises.