The MPC decided to keep policy rates unchanged and continued stance at neutral. This was largely expected even as, despite strong indications to the contrary from recent interviews of the Governor, some sections of the market had built back hope for a 25 bps cut. The more notable aspect of the policy was that RBI/MPC have further lifted the bar for the next rate cut. This then counts as what is generally termed as a ‘hawkish hold’, and the same is being expressed as rise in yields post the policy announcement.
The updated RBI forecasts for growth and inflation are as follows:
The hawkish takeaways for the market are as follows, in our view:
- RBI has marked down FY26 CPI forecast by 60 bps and yet RBI/MPC have focused on how most of the fall is attributable to volatile food prices, that core inflation is steady around the 4% mark, and inflation is projected to go up from the Q4 FY26. Indeed, the projected CPI for Q1 FY27 is 4.9%.
- Growth assessment is quite strong with private consumption said to be aided by rural demand and fixed investment by government capex. Strong monsoons, and robust services and construction sectors, are flagged as positives even as weakness in the industrial sector is noted. Uncertainties are largely from the global side including from tariff announcements.
We turn next to some observations on RBI’s revised approach and conclude with our own assessment.
RBI’s Recent Approach and Market Implications
As is well known and appreciated by now, RBI / MPC have been proactive and upfronted in delivering monetary easing; both on rates and liquidity. This has been to enable faster transmission so that benefits of monetary easing are felt quicker across the economy. Seeing most of its job done, and presumably to caution against excessive continued reliance on incremental monetary easing, the MPC changed stance in the last policy. With today’s policy, the rationale for the stance has been, if anything further fleshed out (refer points above) thereby further raising the bar for any rate cut.
For the market this has been a bit of a problem, mildly put. The first flush of monetary easing was much greater than expected (especially OMOs) thereby setting market expectation a certain way. Then in a relatively very short span of time, the stance has been changed and focus now is on forward inflation. It is to be noted that there is still forward easing in the pipeline in the form of the committed CRR cut pending. From RBI / MPC’s standpoint, this evolution looks perfectly rational as mentioned above. We disagree as by doing this, RBI/MPC is compromising its own transmission via actively working against the expectation channel (rates, liquidity, and communication are 3 important tools of monetary policy). But let’s set our disagreement aside for the time being.
More broadly speaking, macro-economic cycles aren’t as short and sharp as RBI’s actions and communication have been. Thus the global cycle slowdown is well and truly underway and India is bound to feel that as well. Indeed, nominal growth has already slowed significantly domestically as seems evident from corporate commentary in the ongoing season, as well as negative growth rates in corporate and income tax collections year to date. While RBI’s proactive action may serve to limit the extent of local downturn and help foster a quicker recovery, this will work on the margin and is unlikely to neutralize most of the impact of the global slowdown. Thus, for market participants this has been a bit of a digestive issue: from more aggressive than expected easing to a sudden turn to hawkishness, all when the underlying economic cycle is still going one way and the bulk of the global slowdown is still unfolding. This has reflected in a much steeper yield curve than what is warranted at this point in the economic cycle in our view (even as these may be consistent with what is generally been seen at end of rate cycles). As an aside, and partly in jest, we observe that given RBI’s focus on transmission to loan rates rather than market rates, it makes imminent sense for the government to reroute some of its borrowing as loans from banks. This will serve the dual purpose of providing banks with some good quality loan growth, as well as correct some of the bond supply indigestion currently being faced by the market!
Takeaways
While the bar for the next cut has decidedly gone up, the discussion on the table really was for the last 25 bps for most people. It is more the stance and the accompanying hawkish commentary, with the accompanied set back to the expectation channel, that is largely leading to the ongoing turbulence in the bond market. However, as noted above, the global economic cycle is unfolding a certain way that is consistent with a bullish outlook for bonds. For the US we are focused on the slowing private domestic final purchases. With the largest economy slowing, there doesn’t seem to be an obvious contender of similar size to take up the slack for now. In India, a long period post pandemic retail leverage cycle is slowing, and corporate capex demand is patchy. Thus, bank investment books are bound to grow and with a funding rate of below 5.5% for the foreseeable future, and with the strong likelihood of global bond yields also breaking lower over the next few quarters, we expect bond demand to be reasonably strong once the dust is allowed to settle on RBI’s communication. Thus, the current close to end-of—cycle term spreads are quite attractive in our view given that these aren’t coinciding with a turn to the global economic cycle. The assumption here of course, and one we are comfortable to make, is no major conscious fiscal expansion is undertaken by the government.
Source: RBI and Bandhan Internal Research
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