RBI Policy – Fixed income party continues, for now

By Gaurav Kulshreshtha | 05 APRIL 2018

The First Bi-Monthly Monetary Policy Statement for FY 2018-2019 was released by RBI today. Following were the highlights.

  1. Repo Rate left unchanged at 6.00%.
  2. The “neutral” stance continues.

Consequently, reverse repo rate remains unchanged at 5.75% and the marginal standing facility (MSF) rate and Bank rate also remains unchanged at 6.25%.

Out of the 6 MPC (Monetary Policy Committee) members, 5 voted in favour of the monetary policy decision, while 1 voted for a 25bps hike in repo rate.

RBI expects the pace of economic activity to accelerate in 2018-2019 owing to clearer signs of investment revival indicated by sustained expansion of capital goods along with improving global demand that is expected to improve exports and boost fresh investments. They project India’s GDP growth to strengthen from 6.6% in FY18 to 7.4% in FY19 (in the range of 7.3-7.4% in H1 and 7.3-7.6% in H2), with risks evenly balanced.

On the inflation front, RBI has reduced its CPI (Consumer Price Inflation) forecasts quite substantially from the February policy statement. They now expect CPI to average 4.7-5.1% in H1 FY19 (previously 5.1-5.6%) and 4.4% in H2 FY19 (previously 4.5-4.6%), including the HRA impact for central Government employees, with risk tilted to the upside.

10 yr G-Sec movement around the last 8 RBI Policy announcements

Source: Bloomberg

Assessment & Outlook

The rather large downward shift in H1 FY19 CPI inflation forecast (~45 bps) along with a modest one for H2 FY19 (~15 bps) implies a full year revision of ~30bps to the CPI forecast. Interestingly, the policy statement also provides a CPI forecast excluding the HRA impact (4.4-4.7% in H1 FY19 and 4.4 per cent in H2 FY19), which is further ~30bps lower in H1 and this has been emphasized with an underline. Although inflation forecasts have been brought down significantly, the MPC statement highlights that there are more significant risks to the upside and none to the downside.

Citi economists believe that If these CPI forecasts do materialize, then the need for policy action in FY19 would be minimal. In their opinion, while Oil price risk is adequately factored in the RBI baseline CPI forecast (India crude basket estimated @ US$ 68/bbl in FY19), the upside risk from MSP increase could push CPI projections higher in the August policy, by when there will be more clarity on MSP revisions. Hence they believe, this will rule out any RBI move in June policy. Also, the lower new baseline CPI forecast implies that even after absorbing the MSP risk, headline inflation might remain within RBI’s broad comfort zone. This further supports Citi economists view of a long pause.

The 10 yr G-sec closed @ 7.127% down sharply from the previous close of 7.294%, as the market cheered the MPC outcome. Citi economist believe that the readjustments in the demand supply factors over the last couple of weeks may drive the yields lower and a potential increase to FPI limits on government debt securities may add to the rally. They however are cautious in the medium term and highlight that persistent challenges Viz. deteriorating Balance of Payment position, rising risk premium ahead of general elections and continuing challenges for fiscal consolidation will ensure that a sharp rally in Indian fixed income will be hard to sustain, especially if realized GST revenues continue to lag budget projections. Clients with significant overexposure to duration may use this rally as an opportunity to reduce duration and become more diversified in their fixed income portfolios.

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