Bold Is Back : RBI Policy Feb 2020
We had titled our December 2019 policy note “Back to the Book” (https://www.idfcmf.com/article/1042), noting our surprise on not so much the status quo but the possible underplaying of the continued space for countercyclical role for monetary policy in the near term. We had found the larger than anticipated focus on supply side inflation in the face of a 3 – 4% fall in nominal GDP for the year somewhat difficult to square with. We had, however, found some resolution when the RBI subsequently unveiled “Operation Twist” to help accelerate transmission even as near term projected CPI was threatening to cross 7%. The policy unveiled today has offered further the evidence that the RBI is indeed following a practitioner’s approach to policy and that while the Monetary Policy Committee (MPC) may not have room currently to cut rates on the back of higher near term CPI, the RBI has other tools in its tool-kit to continue with its countercyclical responses.
First from a MPC standpoint, the status quo delivered on policy rates was fully expected and par for the course. Given the uncertainties with respect to near term inflation trajectory, any prudent committee will await further information. This is especially true since, as noted in the policy document, there are pressures beyond only in vegetables (milk and pulses for instance) in the current trajectory of prices. To its credit, however, the MPC hasn’t muddled communication and has clearly recognized space to act in the future. Implicit here seems to be a greater recognition of the growth-inflation trade-off for now rather than a point focus on 4% CPI at all points in time. Thus, the MPC has kept the accommodative stance and guidance for future easing alive on the back of an assessment that CPI slides to 3.2% by Q3 FY 21, even as the average CPI for FY 20 breaches 4% comfortably and so does the average forecast for the next 3 quarters. The associated data is shown in the table below:
Source: RBI, IDFC MF Research. Note: Numbers in blue font are derived.
The bigger points in the policy, however, really pertain to what the RBI has done beyond its representation in the MPC. These concern the liquidity operations of the central bank. The daily fixed rate repo and four 14-day term repos every fortnight being conducted, at present, are being withdrawn. It has also been decided that from the fortnight beginning on February 15, 2020, the RBI shall conduct term repos of one-year and three-year tenors of appropriate sizes for up to a total amount of INR 1,00,000 crore at the policy repo rate. This should encourage banks to undertake maturity transformation smoothly and seamlessly so as to augment credit flows to productive sectors, as per the central bank. Additionally, it has been decided that scheduled commercial banks will be allowed to deduct the equivalent of incremental credit disbursed by them as retail loans for automobiles, residential housing and loans to micro, small and medium enterprises (MSMEs), over and above the outstanding level of credit to these segments as at the end of the fortnight ended January 31, 2020 from their net demand and time liabilities (NDTL) for maintenance of cash reserve ratio (CRR). This exemption will be available for incremental credit extended up to the fortnight ending July 31, 2020.
Implications and Strategy
Our continued assessment over the past few months has been that there possibly has been a general under-appreciation of the gravity of our current slowdown (https://www.idfcmf.com/article/996). We have therefore had great sympathy for continued counter-cyclical responses even as the need for more urgency on structural reforms cannot be underplayed. Our only point has been that there needs to be adequate appreciation of where the maximum depth available is for countercyclical response. We have also been cognizant of the moral hazard issue when exploring the avenues for non-traditional responses. For that reason, while we have been happy to support a twist or outright open market purchases of bonds, we have baulked at endorsing a ‘bail-out’ package for stressed balance-sheets. The rationale for our support to the former has been documented in detail elsewhere. Looked at from this general lens, we find today’s policy quite consistent with the underlying macro-environment. This is especially also given the new threat to global growth in the form of the Coronavirus as well as the obvious limits to fiscal policy that have been clearly evident in the just announced Union Budget.
From a strategy standpoint, the value in quality front end bonds (up to 5 years) stands reaffirmed after today’s long term repo announcements. These repos will enable participants to lock in the current cost of money for longer and then deploy as per risk appetite. At the very least, it should enable greater appetite for front end sovereign bonds. Importantly, the RBI Deputy Governor has kept these operations distinct from durable liquidity operations like open market purchase of bonds. The Governor, in his turn, has clarified that the intent behind twist operations has been to strengthen transmission into corporate bond yields. Sporadic twist operations are thus quite likely in the future, although the urgency may not be as great immediately given new tools for transmission that have been unveiled in the policy (long term repo and selective CRR dispensation).
In our actively managed bond and gilt funds, we have been heavily overweight ‘high beta’ 13 year government bonds till after the budget, basis our view that the market was perhaps over-fearing the event. Since the budget we have shifted these portfolios more in favor of 8 – 10 year government bonds on the higher absolute value offered in this segment and since the “momentum” trade generated post budget may have soon dissipated. We find this positioning conducive to the announcements today. Government bonds up to 5 years or so may find even greater support now in context of the long term repo operations. For ‘real money’ that wants somewhat higher duration given an otherwise conducive rate environment, the 5 – 10 year part of the curve may thus offer reasonable value. As always, this strategy represents our current thoughts and is subject to change at short notice in light of market dynamics and our own evolving assessment.
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