The Event
The RBI kept all rates unchanged as was the broad consensus. The assessment was broadly consistent from before. On growth, the role of government policy in accelerating investments was emphasized yet again. On inflation, while the central bank acknowledged the recent softening due easing global commodity prices and weaker local pricing power, food inflation has been highlighted as a clear source of worry. Also pressures from suppressed inflation release on account of hike in administered prices as well as effect of recent rupee depreciation may pose upside risks. On the current account, while the RBI estimates some improvement this year, the main challenge still is to bring overall CAD to a ‘sustainable level’ and in the meanwhile finance it through stable flows. In terms of forward guidance, the RBI is fairly open ended saying stance will be determined by how growth, inflation and balance of payment situation evolve in the months ahead. Importantly, it emphasizes that it is only durable receding of inflation that will open up space for monetary easing. The vigilance on external risks is also intact with the RBI saying it stands ready to use all available instruments and measures to respond rapidly and appropriately to any adverse development. However, the explicit mention that policy can move in either way to respond to external risks has been deleted.
Interpretation
While a status quo on rates was very much expected, market has interpreted the open ended guidance as being lesser hawkish than the last policy. That coupled with the technical reason that most participants were light on duration, has led to a rally in bonds. In our view, the tone suggests more of a wait and watch approach which may extend should the balance of data deteriorate. The reference to ‘durable receding of inflation’ suggests that the RBI wants to look at more than one data point from here in order to ascertain that the risks mentioned don’t change the inflation trajectory. A similar stance seems to be in evidence when assessing external risks as well. The focus on ‘adverse developments’ argues against an immediate hurry to ease on some marginal easing of external (chiefly rupee) pressures.
Going Forward
The next immediate trigger will clearly be the US Federal Reserve meet this week. Should the Fed move decidedly to soothe fears on policy and hence trigger a strengthening of the rupee, then the market may extend today’s gains. Conversely, should the currency depreciate as an outcome of the Fed meet, the market may again adopt a cautious stance in the near term. However, what matters more for investors is the medium term outlook and takeaways. From that standpoint, nothing changes from the assessment that we have described earlier. Broadly speaking there is now greater appreciation of two-way risks and hence likelihood of greater two-way price volatility till some of the macro-risks described here and before iron out. The government bond market enters a period of more than INR 150,000 crores of net supply between here and end August. Besides, most of the current actively traded bonds will soon go off-run which will also have to be factored by the market. Against these, the liquidity outlook argues against OMOs in the near term as government spending has picked up and the system sees some seasonal reversal in currency in circulation during this period. Overall, market may continue in a trading range given these triggers, with rupee and the external account clearly posing the largest near term vulnerabilities. Shorter end rates don’t need RBI rate cuts to be well supported. However, currency stability is a key requirement for performance of all parts of the bond curve.
The RBI kept all rates unchanged as was the broad consensus. The assessment was broadly consistent from before. On growth, the role of government policy in accelerating investments was emphasized yet again. On inflation, while the central bank acknowledged the recent softening due easing global commodity prices and weaker local pricing power, food inflation has been highlighted as a clear source of worry. Also pressures from suppressed inflation release on account of hike in administered prices as well as effect of recent rupee depreciation may pose upside risks. On the current account, while the RBI estimates some improvement this year, the main challenge still is to bring overall CAD to a ‘sustainable level’ and in the meanwhile finance it through stable flows. In terms of forward guidance, the RBI is fairly open ended saying stance will be determined by how growth, inflation and balance of payment situation evolve in the months ahead. Importantly, it emphasizes that it is only durable receding of inflation that will open up space for monetary easing. The vigilance on external risks is also intact with the RBI saying it stands ready to use all available instruments and measures to respond rapidly and appropriately to any adverse development. However, the explicit mention that policy can move in either way to respond to external risks has been deleted.
Interpretation
While a status quo on rates was very much expected, market has interpreted the open ended guidance as being lesser hawkish than the last policy. That coupled with the technical reason that most participants were light on duration, has led to a rally in bonds. In our view, the tone suggests more of a wait and watch approach which may extend should the balance of data deteriorate. The reference to ‘durable receding of inflation’ suggests that the RBI wants to look at more than one data point from here in order to ascertain that the risks mentioned don’t change the inflation trajectory. A similar stance seems to be in evidence when assessing external risks as well. The focus on ‘adverse developments’ argues against an immediate hurry to ease on some marginal easing of external (chiefly rupee) pressures.
Going Forward
The next immediate trigger will clearly be the US Federal Reserve meet this week. Should the Fed move decidedly to soothe fears on policy and hence trigger a strengthening of the rupee, then the market may extend today’s gains. Conversely, should the currency depreciate as an outcome of the Fed meet, the market may again adopt a cautious stance in the near term. However, what matters more for investors is the medium term outlook and takeaways. From that standpoint, nothing changes from the assessment that we have described earlier. Broadly speaking there is now greater appreciation of two-way risks and hence likelihood of greater two-way price volatility till some of the macro-risks described here and before iron out. The government bond market enters a period of more than INR 150,000 crores of net supply between here and end August. Besides, most of the current actively traded bonds will soon go off-run which will also have to be factored by the market. Against these, the liquidity outlook argues against OMOs in the near term as government spending has picked up and the system sees some seasonal reversal in currency in circulation during this period. Overall, market may continue in a trading range given these triggers, with rupee and the external account clearly posing the largest near term vulnerabilities. Shorter end rates don’t need RBI rate cuts to be well supported. However, currency stability is a key requirement for performance of all parts of the bond curve.
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