The MPC kept rates and stance unchanged with the expected one dissent. The Governor flagged global risks from debt overloads and geopolitics, and the recent upturn in oil prices. At the same time, he articulated the contrast in India which is experiencing fiscal consolidation, robust growth, sound external account and buffers, and a moderating inflation trajectory. Risks to local inflation are largely from food price uncertainties and oil prices, although an expected record Rabi wheat production in 2023 – 24 and early indications of a normal monsoon ahead should help with the former.
Economic projections from RBI are summarized below:
Hear, Hear
The policy was as business as usual as one could have imagined, save with the added utility of assuring us again that RBI continues to be a risk manager and preserver of financial stability. For investors looking for continued improvement in India’s macro risk perception, which is our central investment thesis currently, this is very important to hear. As opposed to this, and only as a thought experiment, imagine the Governor having sounded dovish today with the current order of global uncertainties, and with local growth not needing any support from monetary policy. Bond market would have welcomed it but one would have to again start thinking tactically rather than structurally. Rather what stands out for us are these words from the concluding paragraph in the Governor’s speech laying out how RBI will contribute to the transformational journey ahead:
“The Reserve Bank will continue to focus on preserving financial stability and promoting a system that is robust, resilient, and future-ready to support economic growth. Price stability will be a key component of this endeavor”. Alongside a government focused on fiscal transformation, the above statement of intent from the central bank is, as mentioned above, exactly what provides comfort to investors bullish for the long term.
That said, there is very little here for even somewhat more medium term investors to be disappointed about. While the Governor did also refer to it, we already know from actions that RBI has been active in infusing core liquidity over the past few months thereby unwinding the ‘back door’ hike of late last year. Thus, the intent of ensuring fuller transmission of past actions is now only associated with a steady policy rate and not also with an intentional liquidity squeeze; as markets had started to fear for a while till the last quarter. In summary, therefore, one has a central bank that is doing 3 things:
1. Actively providing sufficient liquidity with a focus on anchoring overnight rate to repo. This leaves an attractive spread between overnight rate and even short duration bonds.
2. Deriving comfort from sound local macros and projecting for this soundness to continue over the next year.
3. Providing assurance that it remains a risk manager to ensure meeting of policy targets.
Very tactically, however, the market is understandably a bit cautious in the very short term given pick up in global rate volatility and the recent rise in oil prices.
Bond Market Perspectives
Our key message to investors remains that reinvestment risk is the number one risk in fixed income to guard against going forward. This view is basis an assumption of continuity in policy framework and direction from both the government and RBI. As discussed above, the only material thing to note from the policy today was the continued reaffirmation from the central bank that this is indeed the case.
More to the point from a here and now perspective, overnight rate is now more firmly anchored to repo rate and the yield curve is decently positive. Bond valuations are attractive and yields have moved down by only 25 – 30 bps from the highs of last year. During this time we have had bond index inclusion and strong inflows already from foreign investors, a strong commitment to fiscal consolidation in the interim budget, lower than expected government bond supply announcement, a continued fall in local core inflation, and RBI easing its liquidity stance visibly. Hawkish arguments are all global, chiefly the pain of aggressive US fiscal policy and, more recently, the rise in oil prices. However, as we have discussed before, there are important partial offsets to the former with growth-inflation dynamics more subdued in other major developed markets. With respect to the latter, while one has to be watchful, there are strong local buffers on external account to start with. Also importantly, RBI’s assumption is of USD 85 / barrel on oil: not a mile away (so far) from where the current prices are.
Shorter term bonds (upto 5 years) are also well poised in our view with change in liquidity stance, onset of lean season of credit, and lower supply on short governments and treasury bills versus same period a year ago. To clarify, however, we remain focused on 30 year government bonds in our active duration bond and gilt funds (>90% exposure).
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