RBI Credit Policy Review: The Wise Men Remain ‘Neutral’

Joydeep Sen

The Monetary Policy Committee (MPC) presented its Second Bi‐monthly Monetary Policy Statement for 2018-19 on Wednesday. It raised rates by 25 basis points after almost four-and-a-half years. Overnight repo rate now stands at 6.25 percent and the reverse repo rate automatically rises to 6 percent.

There are some other changes but they are more relevant for bankers and wholesale debt market participants. These are: a) For liquidity coverage ratio (LCR) purposes, banks will now be allowed 2 percent more interest on their  G-Sec holdings under the statutory liquidity ratio. This marginally reduces demand for government securities from banks. b) Valuation of state government securities (SDLs) will be market-based instead of at a uniform spread of 25 bps over G-Secs earlier. This move has an adverse impact on marked-to-market portfolio of banks.

What does the review hold for retail market participants?
Inflation is the biggest variable watched by the Reserve Bank of India for policy rate decisions, and in turn by investors to gauge the central bank’s outlook. Its outlook on consumer inflation for the first half of FY19 now stands 4.8-4.9 percent, revised down from 4.7-5.1 percent earlier. For the second half, the projection now stands at 4.7 percent from 4.4 percent earlier. So for the first half of the year, there is a more specific band now and for the second half, there is an upward revision.

Market movement
The market movement has been little adverse, though yield levels had already moved up in anticipation of a rate hike by the MPC. The 10-year benchmark G-Sec yield moved up from 7.83 percent prior to the announcement to 7.91 percent at close on Wednesday. The market reaction was due to a combination of factors like rate hike, MTM impact of SDLs, marginally lower demand for G-Secs because of LCR change and slight uptick in inflation projection.

At the shorter end, yields on money market instruments have eased. Banks, especially in the private sector, will issue lesser quantum of commercial deposits as they will have the advantage of 2 percent more from SLR for LCR purposes. Normally, a hike in overnight repo rate would mean money market yields moving up, but the same had earlier moved up, making Wednesday’s rate hike almost non-relevant.

Market outlook
Given the extent to which yields in the market have moved up even before Wednesday’s policy review, the market has already discounted the rate hikes. From now on, the market movement will depend on: a) Whether state-run banks are actively participating in the market; b) Data points like inflation; and c) Other relevant developments like RBI open market operations, whether foreign institutional investors are buying in India, movement of crude oil prices, minimum support price hikes, etc.

The previous policy review on April 5 was taken positively by the market as inflation projection was revised downward. However, the minutes of the meeting, published on April 19, show that MPC members were hawkish in their view despite of a more benign inflation projection. The minutes of Wednesday’s meeting are due on June 20, which will offer some clues on the thinking of MPC members.

Remarkably, this time all 6 members of the MPC voted in favour of the rate hike, while retaining the flexibility of a ‘neutral’ policy stance. It means the minutes that will be released on June 20 may give some clue on future rate action, not so much about the hawkishness of individual members.

Takeaway for investorsIn an article dated April 6,  we had said that the “advisable path for investors is to remain conservative and invest in short to medium maturity bond funds”. That view has been reinforced in Wednesday’s policy, even though the official policy rate stance remains neutral. The reasons being: a) MPC has hiked rates even with its neutral stance; b) Inflation projection has been revised marginally upward; c) Further rate hike of 25 to 50 basis points cannot be ruled out; d) Longer maturity bonds or bond funds may be volatile; and d) There is enough ‘value’ at the shorter end of the yield curve.

The yield on the 3-year AAA rated corporate bond is about 8.5 percent, which is very attractive. There is no compelling reason for investors to take duration risk: invest in longer maturity funds when shorter maturity funds are offering ‘value’.

Source: https://www.moneycontrol.com/news/opinion/rbi-credit-policy-review-the-wise-men-remain-neutral-2584659.html

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