There is more room for the Reserve Bank of India (RBI) to cut rates even after the recent 25 basis point (bps) cut earlier this week, and it is likely that the central bank will do so one more time before the end of calendar year 2017 (CY17) given the high real interest rates in India, writes Christopher Wood, managing director and equity strategist at CLSA in his weekly note, GREED & fear.
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The real interest rate in India (difference between the yield on risk-free sovereign treasury-bill and the headline CPI) stands at around 4.7%, is also the reason why the rupee has remained strong, Wood notes.
Recently, the largest state-owned bank, State Bank of India (SBI) cut interest rates on savings bank deposits by a 50 bps citing high real interest rates. It introduced a two-tier interest rate structure on savings bank deposits. With effect from July 2017, a savings bank balance of over Rs 1 crore will earn an interest rate of 4% per annum (p.a.), while the ones with Rs 1 crore or less will earn an interest rate of Rs 3.5% p.a.
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Markets, especially the banking stocks, gave a thumbs down to the RBI’s move to cut the repo rate by just 25 bps earlier this week – the first cut since October 2016 – making it the first Asian central bank to do so thus far in calendar year 2017 (CY17).
While reviewing the monetary policy, RBI continued to maintain a ‘neutral’ stance, citing risks to inflation going ahead. This triggered a negative reaction in the stock market, which expected the central bank to be more accommodative and cut rates aggressively given that the recent consumer price inflation (CPI) print came in at 1.54% for June – much below the Monetary Policy Committee’s (MPC’s) target range of 2% – 6%.
The local mutual fund boom, Wood says, is not just confined to stocks. Inflows into bond funds have also been surging, which has helped drive a boom in corporate bond issuance.
“The growing mutual fund ownership of corporate bonds is also leading to a more active secondary bond market. Still one risk to this bond issuance boom is that foreigners have nearly reached the limit of what they can own in terms of corporate bonds,” he says.
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As regards the stock market, CLSA is of the view that a correction, if it happens, is more likely to be a globally correlated one, since the Indian domestic fund flow momentum remains robust. CLSA is also of the view that the long-awaited earnings rebound should finally occur in the fourth quarter of CY17 (Q4CY17) given the low base effect from last November’s demonetisation.
Banking sector, Wood says, is on the right track as regards addressing the bad asset problem with the non-performing loans (NPLs) of 12 corporate groups formally being referred by the RBI to the National Company Law Tribunal (NCLT).
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“The political reality is that the growing likelihood that Modi will be re-elected in 2019 is another reason for these delinquent corporate borrowers to agree to some form of a deal. This is because it means there is no near-term prospect of returning to “business as usual”, which historically for many Indian “promoters” has meant effectively treating state-owned banks as their own private piggy banks,” he writes.