Santa Claus says Ho Ho ....India policy rates maintained at status quo.....(From Lakshmi Iyer) & Note on Policy

On the basis of an assessment of the current and evolving macroeconomic situation at its meeting today, the Monetary Policy Committee (MPC) decided to keep the policy Repo Rate under the liquidity adjustment facility (LAF) unchanged at 6.5%. Consequently, the reverse repo rate under the LAF remains at 6.25%, and the marginal standing facility (MSF) rate and the Bank Rate at 6.75%. The RBI also maintained their monetary policy stance of calibrated tightening. Six members voted for no change in repo rate. Five members voted for no change in stance while one (Prof. Dholakia) voted for change to “neutral”.

 

Further, in order to align the SLR (Statutory Liquidity Requirement) with the LCR (Liquidity Coverage Ratio) requirement, it was proposed to reduce the SLR by 25 basis points every calendar quarter until the SLR reaches 18% of NDTL (Net Demand & Time Liabilities). The first reduction of 25 basis points will take effect in the quarter commencing January 2019

 

This was a wonderful Xmas gift to the bond markets, which otherwise had been parched of liquidity, and hence lack lustre!

 

 

Key highlights of the policy

 

Inflation outlook

·         In the fourth bi-monthly resolution of October 2018, CPI inflation was projected at 4.0% in Q2:2018-19, 3.9-4.5% in H2 and 4.8% in Q1:2019-20, with risks somewhat to the upside.

·         The actual inflation outcome in Q2 at 3.9% was marginally lower than the projection of 4.0%. However, the October inflation print at 3.3% turned out to be unexpectedly low

·         Assuming a normal monsoon in 2019, inflation is projected at 2.7-3.2% in H2:2018-19 and 3.8-4.2 % in H1:2019-20, with risks tilted to the upside

·         The broad-based weakening of food prices imparts downward bias to the headline inflation trajectory, going forward. However, in contrast to the food group, there has been a broad-based increase in inflation in non-food groups.

·         While the international crude oil prices have declined sharply since the last policy, it is important to monitor their evolution closely. The price of Indian crude basket collapsed to below US$ 60 a barrel by end-November after touching US$ 85 a barrel in early October

·         The MPC noted risks to inflation remained from: (1) sudden reversal in volatile perishable items, (2) uncertainty on impact of MSP, (3) medium term outlook of crude prices is still uncertain, (4) volatility in global financial markets, (5) household’s inflation expectation (one-year ahead) remains elevated and unchanged, (6) fiscal slippage at the centre and/or state levels, (6) staggered impact of HRA revision by the state governments

 

Growth outlook

·         GDP growth for 2018-19 has been projected at 7.4 % (7.2-7.3% in H2) as in the October policy.

·         The growth for H1:2019-20 has been projected at 7.5%, with risks somewhat to the downside

·         The acceleration in investment activity also bodes well for the medium-term growth potential of the economy

 

 

Outlook and way forward

 

-          The status quo was in line with expectations…falling crude oil prices has aided this decision. However, given that sustaining low oil prices is key, we believe that policy rates seem to be on a long pause for now  

-          CPI also would a key variable for markets to track given the sharp reduction in RBIs target for 2H FY 19 as also 1H FY 20

-          SLR cut and OMO purchase to play tug of war, but given the current tailwinds, there seems to be lid cast on northward movement in bond yields

-          Commitment to maintain liquidity augurs well both for long as also short end of the curve. Seems like we get to see OMOs for Jan- March quarter as well which is great news for long bonds

-          Conducting long term repos is likely to help the short end of the curve as well

-          We have seen a good widening of spreads between govt bonds and corporate bonds. The corporate bond yields have not eased in the same quantum as govt bond yields. Hence we prefer corporate bonds across maturity and rating profile

-          INR is likely to find some cushion after a tumultuous past. The softening in US rate stance also bodes well for EM currencies including India

-          Fiscal deficit and politics would continue to be key risk factors to watch out for, hence any sharp slide in yields from these levels may not sustain

 

We had mentioned in our previous note captioned “Gear change from neutral to calibrated tightening... Status quo on rates maintained....” that …excessive fear kind of scenarios are where one could realise better value for the buck… we seem to be in one such scenario right now! Important is to stay the course…. This seems to have truly played out in the last 60 days, where long bond yields have actually eased by over 60 bps (0.60%). So cut the noise….focus on news… and as Warren Buffet says “ Be fearful when others are greedy and greedy when others are fearful..”

 

On that note – Happy investing