Against our and market participants expectations of (25 bps hike) today, RBI maintained status quo. However, they changed the monetary policy stance from “Neutral” to “Calibrated Tightening”. Further policy rate hikes will be data dependent.
KEY HIGHLIGHTS OF THE MONETARY POLICY RELEASE
- Global economic activity is resilient despite ongoing trade tensions. Growth trends are asymmetrical as divergence in growth seen within developed economies (DMs) as well emerging economies (EMs).
- Owing to spurt in crude price and tighter labour markets led to rise in inflation in both DMs and EMs.
- US dollar strengthened further in view of the Fed rate hikes which resulted in depreciation of EM currencies.
- Domestic high frequency indicators suggest softness in consumption demand and services activity in recent times.
- While core and industrial segments growth continued to be strong
- The first advance estimates of production of major kharif crops for FY19 suggest food grains production 0.6% higher than last year’s level.
- Seasonally adjusted Corporate Capacity Utilisation increased to the long-term average of 74.9%.
- Based on the Reserve Bank’s business expectations index (BEI) improved, led by enhanced production, order books, exports and capacity utilisation.
- Retail inflation, measured by the Y-O-Y change in the CPI, fell to 3.7% in August, dragged down by a decline in food inflation. While, fuel and light group continued to rise. Headline inflation prints have been slightly below the RBI’s projected trajectory.
- Reserve Bank’s survey of households reported a sharp uptick of 50 basis points in 3-month ahead inflation expectations and one-year ahead expectations moderated by 30 basis points.
- Taking all these factors into consideration, inflation projections have been revised lower to 4.0% (4.6% in Aug’18) in Q2FY19, 3.9-4.5% in H2FY19 (4.8% in Aug’18) and 4.8% (5% in Aug’18) in Q1FY20, with risks somewhat to the upside.
- The MPC notes that global headwinds in the form of escalating trade tensions, volatile and rising oil prices, and tightening of global financial conditions pose substantial risks to the growth and inflation outlook.
- Systemic liquidity moved into deficit during September 11-29 on the back of an increase in government cash balances and Reserve Bank’s forex interventions. The Reserve Bank conducted two open market purchase operations in the second half of September to inject ₹ 200 billion of durable liquidity.
- GDP Growth has touched 8.2%, a high in recent times led by favourable base effect. We believe GDP growth would adjust further in remaining quarters to an average of 7.4% in FY19.
- Despite rising capacity utilisations, a meaningful revival in corporate capex could take place only post general elections.
- Risks to crude prices appear to be up sided for now, as US sanctions on Iranian oil supplies likely to constrain and disrupt supplies. However, US has been making overtures to Saudi to balance supply shortfalls.
- Government revenues have come under strain yet again, with the excise duties getting reduced second time in this fiscal. Volatile markets are limiting its ability to push PSU disinvestments. However, government seems to be confident of improving GST collection in the H2.
- With inflation undershooting its projections in last two months, RBI kept policy rates unchanged.
- However, with enumerating upside risk to inflation, RBI has shifted its stance to “Calibrated Tightening” from its earlier “Neutral” stance.
- This essentially makes the possibility of further hikes in policy rates more pronounced basis the data releases from time to time. This is a clear departure from the earlier neutral stance of keeping all options open at their disposal.
- Currently policy rates have a spread of 200bps to RBI projected upper band in CPI for H2FY19. This is higher than their stated position (125-175 bps) of real rates over inflation. Hence, we think RBI would hold policy rates unchanged for the near term, as long as data is not disappointing meaningfully.
- Post policy market reactions were diverse Currency and equity markets sold off sharply. While 10 Year benchmark G-Sec reacted positively. Equity and currency markets at large were pricing in two hikes at most before any pause, while bond markets were pricing in change of stance and more than two hikes over a year.
Bond valuations and spreads while reacting to most of the negative factors continue to be higher from their historical averages and appears to be in a value zone. For bond yields to trend lower from here, concerns over inflation, fiscal deficit and crude prices must recede further or a meaningful demand from banks and/or FPIs would offer much needed cushion.
Despite of attractive valuations, given the current opaque Interest rate fundamentals, investors are better off by positioning portfolios towards the short end of the yield curve. Hence, we continue to recommend short duration funds, Corp Bond Funds and quality FMPs. Funds with roll down strategy are well poised to gain on account of declining residual duration and spread compression while locking in higher yields.
For Short term liquidity management - Liquid & Arbitrage Funds are preferred over UST & LDF.
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