By: Punam Sharma
The RBI delivered to consensus expectation today by doing the following:
1. Hike repo rate by 25 bps to 7.75%
2. Cut MSF rate by 25 bps to 8.75%
3. Hike cap on term repo borrowing of banks by 0.25% of net demand and time liabilities (NDTL)
With the measures taken today, the process of realigning the LAF corridor is complete with MSF rate being 100 bps higher than the repo rate; as was the case earlier. Furthermore, the RBI has continued forward with its objective of developing the term repo market by incentivizing continued usage of this window; at least till liquidity deficit continues to be in the range it is at today. To recap, banks have 3 liquidity windows (amounting to 0.5% of NDTL each) available to them before tapping into the MSF penalty rate. These are repo, export credit refinance, and term repo. All combined these amount to INR 116,000 crores of liquidity. Any excess deficit will need to be funded via the MSF window.
In terms of stance, the policy is in continuation of what we know of the RBI’s evolving stance under the new Governor (Please refer our note “Of inflation, expectations, and targeting”, dated 15th October for details). In summary, he is concerned about and willing to act to anchor inflation. At the same time there is a clear recognition that this has to be done in the context of weak growth. The RBI has given forward projections for WPI and CPI in the policy (the latter for the first time). The broad assessment is of WPI to remain higher than current levels for rest of year while CPI, despite food inflation softening, will be around or higher than 9% of rest of year. The forward guidance on monetary policy seems entirely neutral and data dependent with the central bank stating that it will ‘closely monitor inflation risk while being mindful of the evolving growth dynamics’.
While the new Governor’s bias is to anchor inflation, there is clear emphasis that it will be done in the context of the weak growth environment. To that extent, his stance hereon looks completely neutral to us. The next prints on inflation are likely to be higher given adverse base effect and still enduring pass through of higher vegetable prices and that of currency depreciation. However, once the benign effect of better agricultural output shows on primary articles’ prices and the currency depreciation pass through is complete, the momentum in inflation prints may begin to come off. Additionally, the RBI currently estimates full year growth at 5% which seems too optimistic especially if the government will slowdown expenditure in days ahead in order to curb fiscal deficit. It is true that Q3 GDP numbers will not be available in time for the RBI’s next policy review in December (RBI expects GDP growth to pick up from Q3). However, if monthly growth indicators continue to be subdued and government expenditure cuts pick up pace, a further rate hike in December may become a question mark. If market expectations take that direction then term spreads on the yield curve may start to shrink further.
The other uncertainty is with respect to the RBI’s liquidity management stance, and hence the outlook for OMOs. In the previous regime, the anchor for liquidity was 1% NDTL for banks. However, the new Governor doesn’t seem to be guided by any sort of a quantitative benchmark on liquidity. Liquidity deficit currently is at 1.5% of NDTL and is expected to go up further as currency leakage continues over busy season and with impending elections. Market will look for more guidance, either in words or actions, on the central bank’s liquidity management stance in the days ahead. If OMOs are resumed to plug incremental liquidity deficit, they may also serve to reduce current term spreads on the yield curve.
Overall market volatility has been compressing over the past few days as the global environment has (at least temporarily) become more favorable and concerns with respect to our current account deficit have abated. With somewhat more insights into RBI’s thinking, today’s policy should serve to further compress volatility as the market may become biased to trade a range for some time. In the near term, concerns with respect to the next inflation readings and a large supply calendar for November may keep sentiment relatively cautious. However, as the benign effects on food inflation from a better harvest and (hopefully) government’s efforts at fiscal consolidation start to show, this should begin to rub off on market sentiment as well.
For investors, we continue to advise matching risk appetite and investment horizon to fund selection. Also, as a general rule, investment horizons amidst heightened market uncertainties should be longer than what they otherwise would be under normal markets.
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 and should not be treated as endorsement of the views or as an investment advice. The information/recommendation 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 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. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the 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.