The bounty has arrived, which the market was waiting for. Taking the popularly tracked parameter of 10-year maturity government security, it had touched 8.2 percent in September 2018 as there was negativity around. Thereafter, it rallied, touching 7.2 percent in December 2018.
The market has been looking at quite a few positives, including easing crude prices, stable rupee, global central banks taking easy policy stance, inflation consistently lower than RBI’s own projections and last but not the least, change of governor at the RBI. Though RBI functions as per a framework, personalities do make a difference.
Earlier, inflation was not only consistently lower than the target rate of 4 percent but also consistently lower than RBI’s own projections. Even in the face of erring on inflation forecast on the higher side, RBI changed stance on policy rate formulation on October 5, 2018, from neutral to calibrated tightening.
Inflation control is a mandate of the RBI, but as long is inflation is under control, growth is something from which we cannot take our eyes off. We are a fast-growing but middle income group economy and growth is a priority. It was perceived in the market that the new governor will do a practical balancing of objectives, not living in a theoretical world with a singular aim of inflation control.
Today, the Monetary Policy Committee (MPC) of the RBI has reduced policy repo rate by 25 basis points from 6.5 percent to 6.25 percent, changed stance on policy rate formulation from calibrated tightening to neutral as well as done a downward revision of inflation forecast. Inflation projection has been revised downward to 2.8 percent for Q4 of FY19 (i.e. Jan-Mar ’19), 3.2 – 3.4 percent for H1 of FY20 i.e. April-Sep ‘19 and 3.9 percent for Q3 of FY20 i.e. October-December 2019.
In the MPC, the voting was unanimous for a change of stance from hawkish to neutral and 4:2 for a reduction in policy repo rate by 25 bps. Certain other measures were taken as well. Risk weight for banks’ exposure to rated NBFCs, which is relevant for capital adequacy purposes, is being changed from 100 percent risk weightage to that as per the credit rating. Guidelines will be issued in February but apparently, exposure to highly rated NBFCs will attract a lower risk, which is positive for bank funding of NBFCs. Currently, we are in a phase of a crisis of confidence in the NBFC sector and liquidity issues, hence this move will be palliative.
Hence we have got three positive shots from the RBI MPC: (a) change of stance to neutral, which implies they can execute further rate cuts in future if they deem fit, (b) rate cut per se, which was broadly expected later, in the April ’19 policy review and (c) easing of inflation projections, which implies that much more scope for policy rate easing in future, as long as inflation moves around the projected trajectory. The unanimous voting of the six committee members for a change of stance to neutral shows us that they are now realising the reality on low inflation, a far cry from 5:1 voting in favour of a change of stance to tightening, on October 5, 2018.
From the bond market perspective, the outlook is positive now, only that we have to be wary of two factors. One, a large supply of fresh bonds in the coming financial year: more than Rs 7 lakh crore of government securities and more than Rs 5 lakh crore of state securities (state development loans), apart from corporate bond issuances.
The other factor is actual inflation trajectory over the next year; as long as it moves around the path projected by the RBI, we are home and can look forward to further policy rate easing. The extent to which easing happens will depend on variables, but 25 to 50 bps over the next one year may not be far-fetched. The NBFC sector crisis of confidence in September 2018 has eased to a significant extent, but for issues in a few NBFC groups. If we pass out of this phase without any default over the next few months, life will be back to normal.
Takeaway for investors
The Union Budget presented on February 1, 2019, was mostly positive for the market, but for a minor slippage in fiscal deficit target for next year. The RBI policy review, the first under the new governor, has been sanguine. Globally, central banks are sounding soft on interest rates. The US Fed, in the meeting on January 30, 2019, added the term ‘patience’ in their statement, which is significant, implying they may not be aggressive on rate hikes in future.
For deployment in bonds/bond funds, the view remains clear. Just be cautious, it is better to avoid (a) long duration funds, to avoid duration-related volatility in your portfolio and (b) fresh exposure to credit-oriented funds for the time being, till the NBFC environment returns to normalcy.