RBI shifts to a more sanguine framework

Last Updated: Fri, Feb 08, 2019 13:52 hrs
RBI

The RBI cut policy rates by 25 bps to 6.25 per cent (voted 4-2) and changed the monetary policy stance from 'calibrated tightening to 'neutral (unanimous vote). Some key points from the Monetary Policy Committee (MPC) meet are as follows:

* The MPC cut its CPI forecasts, with Q4 FY19 now being forecast at 2.8 per cent year-on-year (versus the lower-than-expected actual print of 2.6 per cent in third quarter (Q3) financial year 2019 (FY19) and previous forecast of 2.7-3.2 per cent for second half or H2 FY19) and first half or H1 financial year 2020 (FY20) at 3.2-3.4 per cent (previously 3.8-4.2 per cent).

* Consumer Price Index (CPI) for Q3 FY20 is forecast at 3.9 per cent. It assessed the risks to be broadly balanced around the central trajectory versus 'tilted to the upside' earlier. The MPC noted its benign food inflation outlook, softer prices of items in the fuel-group, complete dissipation of the recent HRA hike and its current judgment of the recent jump in health and education CPI components to be a one-off phenomenon.

* However, it highlighted the reversal in vegetable prices, unclear oil price outlook, rising trade tensions, volatility in financial markets and the impact of various budget announcements, although only over a period of time, on increasing disposable incomes as upside risks.

* On GDP growth, it noted slowing global growth/demand, rising trade tensions and the recent pickup in bank credit growth not being broad-based as headwinds.

* It projected FY20 real GDP growth at 7.4 per cent (7.2-7.4 per cent in H1 and 7.5 per cent in Q3), with risks evenly balanced. Further, it mentioned the output gap has inched lower than potential -- the earlier assessment was that it had closed -- and the need to step up private investments and support consumption. On the global front, it acknowledged the recent moderation in economic activity in the US, Euro Area and China.

There are some significant takeaways. The rate cut decision taken by the MPC is understandable, although the market, including ourselves, had assigned a less-than-even chance of that happening today.

This is largely owing to the context provided by the Budget and the expectation that the recent jump in core CPI, although owing largely to rural health and education, may cause RBI to take more time in its assessment.

However, the cut can be justified owing to the persistent undershoot in headline CPI as well as more sanguine global environment, including worries on global growth. Indeed, that has been our framework for sometime now.

What stands out, however, is that the assessment is considerably more sanguine on almost all aspects. As an example, the RBI Governor actually stepped in to defend the Goods and Services Tax (GST) collection targets set by the government in the new budget; one which has been viewed with suspicion by most.

Also, the impression given is that the new revised CPI targets take into account the possible impact from the consumption stimulus offered by the government in the Budget.

The policy clearly has the stamp of the new Governor. Assessments are bolder and interpretations are more sanguine. There is clear benefit of the doubt for the Government.

Also, the focus seems conclusively back on headline CPI. All this means that the market may look forward to at least one more rate cut, given that the near forecast for CPI remains sanguine.

Against this tailwind, however, the government is slated to borrow Rs 36,000 crore extra in this financial year and a higher than expected Rs 7,10,000 crore in the next financial year. The obvious implication is for the yield curve to steepen as the market is called upon to take higher supply at the duration part of the curve.

In duration, our preference would be for quasi like SDL and corporate bonds rather than Government bonds. While in supply there is a near-term problem, it typically dissipates into the new financial year. Also, starting spreads there are already reflecting higher supply. The most sustainable trade, however, is in 2-5-year AAA corporate bonds.

(The writer is Head – Fixed Income, IDFC)



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