In the run-up to any RBI Monetary Policy Review, the focus of the market is on policy rate i.e. either a change in the rate or guidance on future rate movement. While the policy rate is the core of monetary policy, there are many important aspects of the Monetary Policy Committee (MPC) such as providing guidance on banking system liquidity management, substitution of collaterals under LAF (which is the window for RBI repo and reverse repo), etc.
The next review is on June 6 and 7; RBI will announce the outcome on 7 June. What makes this policy review interesting is the improving economic variables and consequently, the expectation from some segments of the market of easing in the policy repo rate, which is currently at 6.25%.
Many factors indicate that RBI is likely to meet its inflation projection of 4% to 5% in consumer prices:
- Inflation has been benign; CPI for April was only 2.99%. Core CPI was 4.5%, which was on the lower side.
- A normal monsoon is predicted.
- The GST rates are broadly inflation neutral.
- Crude prices are moving in a band.
- The Rupee has been strong.
The latest GDP growth data is another case in point: quarterly growth numbers have been steadily declining. It was 7.9% in Q1 i.e. April to June 2016, 7.5% in Q2 i.e. July-Sep 2016, 7% in Q3 i.e. Oct-Dec 2016 and 6.1% in the latest data point for Q4 i.e. Jan-Mar 2017. The latest decline is due to demonetisation but lower growth could be a reason for further policy rate support to boost the economy, as long as inflation provides room for doing so.
FIIs have been investing heavily in debt in India this year, which is another positive for the markets. The big positive is, real interest rates are positive, even if we take inflation at 4% to 5% instead of the latest data point of 3%.
Driven by the positives discussed above, there is a mild expectation of rate cut or at least a softening of the stance. The change in RBI stance on policy rate came about on 8 February, when the approach was changed from accommodative (meaning further rate easing possible) to neutral i.e. further rate easing unlikely, unless there is a compelling reason. The change in stance took place without any major change in the economic fundamentals. In the Policy Review on 6 April, the statement of some of the members of the MPC had a hawkish undertone, indicating that inflation is under upward pressure. From that perspective, it is unlikely that the MPC would tinker with rates this time around. They may tone down their approach from neutral to accommodative, which would be a little positive for the market.
The other aspect of policy, that is relevant at this point of time is surplus liquidity. In the run-up to the previous policy review on 6 April, when there was surplus liquidity as an after-effect of demonetisation, there were talks of a Standing Deposit Facility (SDF) wherein the banks would deposit the surplus and get some interest. The ball is in the government’s court. On 6 April, pending action on SDF, the RBI reduced the policy rate corridor by increasing the reverse repo rate from 5.75% to 6% and reducing the marginal standing facility (MSF) rate from 6.75% to 6.5%. This move may reduce potential volatility in short maturity rates. Even now, there is surplus liquidity and RBI is trying to manage this through term repos and cash management bills. Since the decision vests with the government, it remains to be seen whether the RBI takes any measure in this regard.
In the bond market, the mood is positive due to lower inflation and expectations of normal monsoon. The new 10-year benchmark G-Sec, 6.79% GoI 2027, is trading around 6.66% and the old one i.e. 6.97% GoI 2026 is around 6.8%. Due to higher demand and lower supply, yield will be low (i.e. price is high) for some more time.
From the financial advisors perspective, there is no action required; this is just a policy review and investment is a long-term game. Guide your clients accordingly.
Joydeep Sen is Independent Bond Market Analyst and Author.
The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.