Why Is RBI Becoming Hawkish?

Why Is RBI Becoming Hawkish?
By Government of India [Public domain], via Wikimedia Commons

Inflation is under control, Currency is well behaved, credit growth at multi year low . “The MPC minutes revealed RBI executive director Michael Patra was of the view a pre-emptive 25-basis-point hike in the policy rate was required to prevent the need for ‘back-loaded’ policy action once inflation was already too high. “The minutes of the RBI’s 6 April policy meeting suggest that the next move will likely be a hike, as highlighted by two MPC members,” Nomura economist Sonal Varma wrote”


I have an alternative explanation for RBI turning hawkish and I think the clue to that lies in the following report

J.P. Morgan is offering regional banks some interesting advice:  Partner Up as U.S. Deposit Drain Looms.. 

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JPMorgan Chase & Co. has some advice for regional banks: A deposit drain is coming,

The company’s investment bankers are warning depository clients that they may begin feeling the crunch in December, thanks to a byproduct of how the U.S. Federal Reserve propped up the economy after the financial crisis, according to a copy of a confidential presentation obtained by Bloomberg News and confirmed by a JPMorgan spokesman.

JPMorgan argues that some midsize U.S. banks —  could face a funding problem in coming years as the Fed goes about shrinking its massive balance sheet, according to the 19-page report the New York-based bank has begun sharing with clients.

The Fed is currently holding about $4.5 trillion of securities. The way it will get rid of them is by letting them mature and not buying new ones.

(my view…..the same advice holds true for all emerging countries because QE and reinvesting proceeds by US FED is single biggest reason for flow into Emerging markets including India)

Deposit ‘Destroyed’

JPMorgan’s presentation, titled “Core Deposits Strike Back” illustrates how this process will sap bank deposits using the example of a couple who pays off a mortgage that was bundled with other mortgages and sold to the Fed. Right now, when that couple takes that money out of their bank account for that payment, the Fed uses that cash to buy another mortgage bond, recycling it back into the banking system.

A “deposit is destroyed” if the “Fed does not reinvest,” the presentation states. and that is what FED intends to do “shrinking FED balancesheet”

Midsize banks will have an especially hard time growing retail deposits by ramping up advertising and investing in branches, according to JPMorgan’s presentation. That’s because they lack the marketing muscle of mega banks such as JPMorgan itself, as well as Wells Fargo & Co., Citigroup Inc., and Bank of America Corp.( my view ……swap midsize banks with EM central banks which does not have sufficiently high interest rate differentials over US rate).

The FED rate tightening itself is not a big deal because it only increases the cost of Liquidity marginally but more importantly LIQUIDITY stays ithe system. Most crisis happens when Liquidity is not available, not when cost of liquidity is going up.US Dollar is the reserve currency of world and the largesse by FED ( in the form of QE and reinvesting the maturing proceds back into market instruments) has allowed liquidity to flow outside US borders into any asset deemed attractive including EM bonds and equities. Now FED is telegraphing its intent to remove liquidity and i think this removal of liquidity is the more important consideration in RBI becoming hawkish and preempting FED by preparing market for a rate hike.

Article by Ritesh Jain, World Out Of Whack

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