Suyash Choudhary

The RBI kept all rates on hold as was broadly expected. Instead, the market had gone into the event looking for changes to the central bank’s inflation assessment and the consequent dovish stance that this may elicit. In that market wasn’t disappointed. Thus while the RBI assesses an immediate rate cut as premature, it considers risks to its 6% inflation targets as evenly balanced now. Furthermore, it states quite unequivocally that a change in monetary policy stance is likely early next year subject to 3 preconditions getting met :  
1) if current inflation momentum continues
2) if changes to inflationary expectations that have started continue,
3) if fiscal developments are encouraging.
In our assessment, we are well on course to meet all of these pre-conditions. Inflation momentum should remain well behaved. In the near term this may be owing to seasonal fall in vegetable and cereal prices alongside second round effects from fuel price fall. In the medium term slowdown in minimum support price (MSP) setting, fall in rural wages, the government’s price stabilization fund, rationalized procurement and distribution policy of food grains; etc should all play their part. Most important here is the renewed institutional credibility with both the government and the RBI working towards bringing inflation down. On inflation expectations, the important point to note is that the RBI is not terribly fussed about the current level of expectations but rather the direction in which they are already moving. Also it stands to reason that as volatility in primary articles’ prices further narrows, inflation expectations should incrementally fall further. Finally on fiscal deficit, while slower revenue growth and delayed disinvestments are pressurizing the near term math, we think there are other levers that the government will pull in order to meet the 4.1% target. The recent diesel decontrol and delay in food security roll out should lead to some savings on budgeted subsidies. The government has announced 10% cut in discretionary non plan spending and media reports suggest a similar cut in plan spending may also be forthcoming. All these should ensure that the target is met, although in a somewhat ad-hoc fashion. More importantly, the interim suggestions of the Expenditure Commission and their possible acceptance in the next budget should give both the RBI and the markets much more comfort about steady fiscal consolidation going forward. All told, and combining our own assessment of data and news flow with what we interpret from RBI today, we would expect the RBI to initiate its first rate cut anytime between the Union Budget at end February and its April policy review.
The other important takeaways from both the policy and the subsequent media interaction are as follows:
1. Once monetary policy stance shifts, it will be for good and subsequent actions will be consistent with this change in stance. To that extent, the signaling effect of the shift in stance will be larger than the first rate cut insofar as it implies that the RBI is now confident that the inflation regime has decisively shifted. This is very similar to our own assessment of RBI under the new regime (please see “Rate Cut Won’t Be an Event But a Process”, dated 22nd October for details).
2. The central bank has clarified, and one hopes once and for all, that OMOs are not yield signals but done solely to regulate the pace of growth of RBI’s own balance sheet in line with its other macro-economic targets.
3. It is likely that the government will accept medium term inflation target at 4% +/- 2% in line with the Urjit Patel Committee recommendations. The Governor clarified that achieving 6% is within limits of this target and will be adequate to signal the shift of inflation to its new lower structural regime that the RBI had set out to achieve.
Investor Takeaways
We have emphasized for some time that what is more important for investors to assess, rather than when the RBI cuts rate, is whether the break of 4% odd in inflation (from 10% to 6%) is for real. For various reasons that we have mentioned above as well as before, we are fairly convinced that this break is for real. Today the RBI has implicitly confirmed this assessment as well. To us this signals important things for how investors should look at their portfolio allocation. A central consideration has to be plugging reinvestment risks on maturing investments via elongating maturities on new and existing investments.
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