The RBI policy came amidst considerably uncertainty with participants, given the underlying global macro backdrop as well as the recent sharp rise in local bond yields. Some quarters were expecting a shift in stance while some were even assigning probabilities for an actual rate hike. As it turned out, the policy turned out to be much more run of the mill. Thus not only was there no rate action but the stance was also kept neutral.
We summarize below our key takeaways both from the policy document as well as from RBI’s media interaction subsequently:
1. The December policy had pegged CPI in the range of 4.3 – 4.7% for H2 FY 2018. The actual outturn for Q3 has been 4.6%. Q4 has been pegged higher now at 5.1%. This upturn is largely owing to less than expected moderation in food prices over winter as well as due to the recent rise in fuel prices. For FY 19, CPI is estimated to be in the range of 5.1 – 5.6% for H1, and then moderate to 4.5 – 4.6% in H2; with risks to the upside. Most factors affecting this are again supply side including oil, higher industrial raw material prices, monsoons, state HRA implementation, and the hike in customs duty in Budget. The demand side risks are from second round implication from state HRA implementation, possibly better ability for firms to pass on higher input prices owing to rise in economic activity, and linkages from fiscal deficit. However, there are two important demand side factors mentioned as mitigants : subdued capacity utilization and still moderate rural real wage growth. Importantly, from the supply side, even though the proposed higher MSP is mentioned as a risk there is also acknowledgement that the impact on inflation cannot be fully assessed at this stage. This point was repeated in the post policy media call as well and is in line with our own thought on the issue, as expressed in our post Budget note.
2. On growth, there is only a marginal downward revision for current year’s GVA to 6.6%. For next year GVA is pegged at 7.2% (7.3 – 7.4% H1, 7.1 – 7.2% H2) with risks evenly balanced. The growth enablers looked forward to include stabilizing GST effect, early signs of investment revival as reflected in resource mobilization picking up and improving capital good demand, the resolution of PSU bank asset issues including recapitalization, and anticipated export pick up. On the downside, the drag from oil is a factor.
Apart from the above, the concluding statement from the MPC seems noteworthy: “The Committee is of the view that the nascent recovery needs to be carefully nurtured and growth put on a sustainably higher path through conducive and stable macro-financial management”. Finally, the voting by MPC members had a hawkish leaning with the traditional dove, Dholakia, opting to join the status quo bandwagon. Whereas, Patra reverted to the disposition he is the most comfortable with and voted for a hike.
In the media call, Governor Patel ascribed the recent sharp rise in bond yields to non-RBI factors entirely; including higher US rates, oil prices, cyclical pick- up in demand in the economy as well as fiscal slippages from the government. Whereas, Deputy Governor Acharya took pains to reiterate that OMOs are done for liquidity management for the most part; although he didn’t seem to rule out exceptional circumstances. This shows lesser sympathy with what is happening in bond markets than what participants may have hoped for. On the other hand, the Governor was quite balanced with respect to the rate stance and defended the decision to keep the stance neutral. The reasons he gave included the fact that ex of HRA CPI is still close to 4.5%, impact from proposed MSP hikes is still not known, and that it may not be necessary for the government to necessarily hit 3% on deficit targets so long as the stance of fiscal policy was conducive to inflation management.
Implications
Our view has been, explained via multiple communications before, that the bar for a rate hike is high currently. We are comfortable reiterating this view post the February policy. The RBI / MPC assessment is quite continuous from the negative output gap that they had assessed in the December policy. Thus recovery is still judged to be nascent and most factors posing upside risks to CPI are largely supply side. If one needs to start ascribing timing for a rate hike (as opposed to actually expecting it as a base case), it is most likely to be not before August. By then the RBI / MPC will have much more information on both some of the supply side drivers of CPI (oil, MSP, monsoons ) as well as be able to assess how enduring and persistent the current cyclical growth upturn is likely to be, in the context of closure of the current negative output gap.
For a RBI / MPC that is still some distance from actively contemplating its first rate hike, there is surely excess fear pricing in the bond market. This makes front end rates (upto 5 – 6 years) a buy and hold trade from a core portfolio standpoint. Longer duration may also tactically make sense at least till meaningful new bond supply hits in April; given oversold markets and with one imminent fear with respect to RBI out of the way. However, one can only take a longer term call on long duration once the current impasse with respect to bond appetite from large local banks is resolved.
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