Tuesday, August 5, 2014

To cut or not to cut is not the only question!

Thought for the day
”There are good and bad times, but our mood changes more often than our fortune.”
-          Thomas Carlyle (Scottish, 1795-1881)
Word for the day
Rimple (v)
To wrinkle; crumple; crease.
(Source: Dictionary.com)
Teaser for the day
President's daughter tells the world that she possesses the personal diary of her father, containing his account of political events in past four decades.
Why does she say this? Is she "assuring", or "threatening", or "warning" someone?

 To cut or not to cut is not the only question!

The complete unanimity amongst forecasters over the likely decision of RBI on policy rates is rather unusual. Overwhelming consensus on any issue involving human intervention always bewilders my strategist mind. Consensus on economic issues is even more perturbing as it is against the basic concept of market. Imagine a market place where only buyers or only sellers are present.
To me this consensus could be outcome of any one or more of the following factors:
(a)   The economic situation in India is too volatile. All forecasters are therefore equally confused about the likely direction in near term.
(b)   RBI is presently faced with unprecedented complexities in policy making.
In a decoupling world, the largest economy USA is doing relatively better and Federal Reserve is moving steadily on the path of tightening the monetary policy and debating the timing of reversing the declining trend in policy rate; whereas other big economies like Japan, China and EU are struggling with growth and are more likely to ease the policy. The currency movements are accordingly also volatile and divergent.
RBI therefore has the unenviable task of maintaining the competitiveness of INR to protect exports; to augment USD reserves to protect the economy against a possible BoP crisis, protecting the interests of importers and borrowers in foreign currency, and at the same time keeping real rates positive to encourage domestic savings which have been on the decline since past few years.
(c)   RBI has mostly failed in ensuring adequate transmission of policy easing in past few years. During past four rate cuts private banks have not transmitted any concession to borrowers, while PSU banks did full transmission only once.
Under these circumstances, from industry stand point policy rate cut becomes more of political decision rather than a monetary one.
Moreover, rate cuts are not necessarily positive for the economy and markets. In a recent report India rating (Ind-Ra), highlighted "...policy-driven change in interest rates has in the past impacted the domestic currency rate. In certain instances, an interest rate cut by the Reserve Bank of India (RBI) was followed by a 1.1%-5.8% depreciation in the Indian rupee one month post the effective date of cut. Around 53% of BSE500 corporates, which account for 70% of the balance sheet debt, have historically suffered a 1.3% EBITDA (by value) erosion for a 1% rupee depreciation, according to Ind-Ras estimates. The benefit of a lower interest rate is thus often muted, and in some cases the impact on credit metrics such as coverage ratio is actually negative.
Under the scenario of a 25bp interest rate cut followed by a 2% depreciation in the currency, the amount of stressed debt within BSE 500 corporates is estimated to increase to 14% from the current amount of 10%. While a 50bp rate cut followed by a 5% rupee depreciation could cause the stressed debt to increase to 21%."

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