The MPC kept repo rate and stance unchanged as was widely expected, although one member voted for stance to be changed back to neutral. The RBI cut SLR to 18% at the rate of 0.25% per quarter starting January. Key highlights as follows:
On CPI
The market got the cut to CPI forecast that it was looking for. In fact, the cut was quite meaningful to 2.7 – 3.2% in H2 FY 19 (from 3.9 – 4.5% in last policy) and to 3.8 – 4.2% in H1 FY20 (4.8% for Q1 FY20 in last policy). Given these numbers one would have expected a much more dovish assessment. However, there seems to be a distinct sense of unease with respect to the durability of the fall in CPI. Thus the MPC noted that the CPI outlook is driven mainly by an unexpected softening of food inflation and collapse in oil prices in a relatively short period of time. Excluding food items, inflation has remained sticky and elevated, and the output gap remains virtually closed. In the post policy call, Governor Patel also referred to the large uncertainties in forecast and that a few more months are needed to see impact of MSP. He flagged risks of sudden reversal especially in perishables. He also noted that volatility indicators in oil have not subsided even though prices have fallen (which means that outlook on oil remains unstable). Finally, he also flagged risks to fiscal slippage as influencing inflation outlook. However, it is here also that Dr. Patel also threw in the first dovish surprise: he said something to the effect that if CPI upside doesn’t materialize, then there is possibility of space opening up for commensurate action. This has given market first hopes in a direction no one was even daring to think about: the possibility of actual monetary easing.
On Growth
There seems to be a clear assessment that global growth is slowing. However, what is somewhat surprising is that RBI still assess the local growth outlook as quite robust. So the GDP forecast is retained at 7.4%, but with risks to downside. Thus global slowdown, financial market volatility, and lower Rabi sowing is considered as risks. But on the other hand, the fall in oil is seen as a strong positive to demand. To be fair, many of the indicators that RBI monitors are still robust. This may be driving the sanguine view on growth and, by implication, output gap. Thus the higher import growth, stable business sentiment in Q3, the strong composite PMI prints released recently, and non-food credit growing at 15% (higher than GDP) were all mentioned as supporting the growth outlook.
On Liquidity
Dr. Acharya explained that RBI was guided by principle of managing system-wide liquidity. It is also the lender of last resort wherever needed, but he didn’t think that was required currently. He defended measures undertaken to alleviate recent HFC / NBFC stress. There was a clear preference highlighted for OMOs and term repos for liquidity infusion. Dr. Acharya mentioned that long term repos will be done around advance taxes. The second dovish surprise came from him when he assessed that increased frequency of OMOs may be required till end of March. Additionally, the Governor was quite emphatic in denying any need for a CRR change.
Takeaways
On the face of it, barring the drastic CPI cuts, the policy was quite neutral. The confidence in growth seems a shade too robust, and we think there may be some downgrades here down the line. In particular, the lagged effect of recent tightening of credit to certain sectors may have been somewhat underplayed. Having said this, the market got everything it wanted. Thus it got confirmation that it was right in unwinding practically all future rate hike expectations. While it is too soon to already start thinking of easing, the statement made by Governor Patel may at least start the discussion at some point. This is especially true if CPI sticks to the forecasted path for the next few months and the current nascent concerns about global growth were to get more amplified going forward. Indeed, the global context is quite relevant here and has been one of our core pillars of fixed income view lately. In this respect, the recent mild inversion between 2 and 5 year US treasuries is inviting a lot of interest as potentially signaling market’s first tentative steps towards pricing in a slowdown ahead, and the Fed potentially making a policy mistake by continuing to hike. These are nascent trends and can easily reverse. But they definitely merit attention, coming as they do on the back of growth slowing materially in large pockets of the rest of the world and in fact the US itself showing some sector specific weaknesses lately.
The other important clarification provided is that OMOs are likely to continue at a similar pace in the next quarter. There was a chance that the pace would have come off in the next quarter. This was basis an expectation that the RBI will not fully plug the core liquidity deficit by end March but may be comfortable with a INR 50,000 – 75,000 crore deficit. However, it looks like that the central bank is likely to be more proactive and may attempt actual neutral core liquidity by March. This could be emanating from a consciousness that there are sector specific liquidity challenges and hence RBI needs to be even more proactive in abundantly delivering on its principle of managing system wise liquidity. This means the favorable demand supply balance for government bonds is likely to continue till fiscal end.
From a strategy perspective, we reiterate here our view that the rate hike cycle is over and that one has to be long on quality fixed income (sovereign / AAA). In our bond and gilt funds we have increased exposure to the 10 year point over the past month or so through a combination of government bonds, SDL, and AAA bonds. At the very least, however, one can no longer be underweight on AAA front end up to 5 years.
Disclaimer:
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.