Analyzing the immediate impact of the announcement by the RBI

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Dec. 4 2020, Updated 10:52 a.m. ET

Expectations and action

The Reserve Bank of India (or RBI) is India’s central bank. It maintained the status quo on its key rates in its fifth bi-monthly monetary policy statement. The statement was released on December 2, 2014. Its policy repo rate didn’t change. The repo rate is 8%. The cash reserve ratio (or CRR) stayed the same at 4%. The repo rate is the RBI’s key rate. It’s the rate at which it lends money to Indian commercial banks. The RBI also uses it to signal an increase or decrease in rates to commercial banks.

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The bank was under tremendous pressure to reduce rates at this policy announcement. It disappointed markets by not cutting rates at its last announcement in September. With the inflation indicators, the wholesale price index (or WPI) and the consumer price index (or CPI) came down drastically in the past three months. Market participants accounted for a rate cut.

Rationale

Even though there were expectations for a rate cut, the RBI didn’t oblige. At the time, the RBI thought that a rate cut would be premature. It still wants to be sure that the disinflation, or slowing of the inflation rate, is sustainable.

In the media conference after its policy announcement, bank officials said that the low inflation rate in recent months was because of a low base. They meant that a high inflation rate prevailed in the previous year. Since inflation is calculated on a year-over-year (or YoY) basis, a high value in the previous year would make a small rise this year seem much smaller. Before they change the repo rate, the officials want to be certain that even if the base affect wanes, the rate of inflation will remain low.

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Equity indices’ reaction

Equities reacted strongly with broad market indices—like the S&P BSE Sensex, the S&P BSE 100, and the CNX Nifty—dropping sharply by 0.60%, respectively, from their previous close levels. However, mid and small-cap stocks didn’t fall as much. The S&P BSE Midcap and the S&P BSE Smallcap indices were down 0.16% each after the announcement. All of these indices recovered as the trading day progressed. In fact, the mid and small-cap indices ended higher than their previous close values.

Exchange-traded funds (or ETFs)—like the WisdomTree India Earnings Fund (EPI), the PowerShares India Portfolio (PIN), the iShares MSCI India ETF (INDA), the iShares S&P India Nifty 50 Index Fund (INDY), and the VanEck Vectors India Small-Cap Index ETF (SCIF)—are susceptible to the RBI’s policy moves. They’re susceptible because they focus on India. As a result, you should watch for developments in this area.

In the next part of this series, we’ll explain why understanding monetary policy implications is vital to your investment–whether or not your investment is in India.

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