Markets cautious ahead of RBI's monetary policy meeting outcome

Stock markets lost early gains and were trading in the red on Wednesday at around 11.10 am ahead of the Reserve Bank of India's (RBI) third bi-monthly monetary policy statement. The BSE Sensex was down 15 points to 32,560. Most of the bank stocks were trading with losses, barring Punjab National Bank that was up almost 1 percent at Rs 159.

The RBI's monetary policy committee (MPC) meeting ends amid retail inflation hitting a new low of 1.54 percent for June, raising expectations of a cut in the key interest rate (repo rate) by a minimum 25 basis points with some hoping for 50 basis point cut. Currently, the repo rate is 6.25 percent.  

Also read: Interest rate cut on savings deposits augurs well for banks, say Nomura analysts

The meeting also comes in the backdrop of a cut in savings deposits by State Bank of India from 4 to 3.5 percent in the wake of rising deposits following demonetisation. The situation is an outcome of a dilemma faced by banks, according to an analyst.

"Deposit growth had surged in wake of demonetisation given the sharp jump in liquidity. This surplus liquidity had seen banks lower their lending rates earlier this year. With remonetisation on track in recent months, deposits have been flowing out thereby raising the incremental funding costs. Hence, to protect margins - which are already under pressure due to rising bad loans, higher due diligence - banks likely mulled over higher lending rates or lower deposit rates – they went with the latter," Radhika Rao, an economist at DBS Bank, said in a note on Wednesday.

It should also be seen as an indicator of expectations of consistent fall in inflation that could lead to a fall in lending rates in the near future. Falling interest rates on fixed deposits along with savings deposits could push investors towards equities and mutual funds in search of better returns.

Stocks bucking the downward trend included Hero Motocorp, NTPC and Lupin.