The monetary policy decision was largely expected to be a non-event with market participants expecting unchanged policy rate amidst higher near term inflation prints. Projections for growth and inflation, to be provided for the first time, were instead being looked forward to, to be poured over in order to gauge the future path of policy. While these were duly provided (-9.5% for real GDP in FY 21 with risks to downside and inflation close to target by Q4 FY21) and rates were indeed left unchanged, the RBI and the monetary policy committee (MPC) have acted and spoken with remarkable clarity and emphasis, leaving no doubt whatsoever as to the thought and intent of monetary policy.
The backdrop for the current policy was set against the market’s recent expressed indigestion with respect to the continued onslaught of bond supply. This had started largely post the last policy and its minutes, but had sustained in a milder form even after reasonable intervention measures undertaken by the central bank including hiking banks held to maturity (HTM) limits by 2.5% of their NDTL and the governor’s clarification on policy stance. The other aspect leading to this market behavior has been more global in nature: the re-opening optimism has been accompanied with much stronger concurrent data in major economies giving continued legs to the “reflation” trade. The rub-offs have been evident in India as well. The bond market’s fading appetite has been well documented in the fact of continued devolutions in 10 year bond auctions over the recent few weeks.
(Re) Enter RBI
The need for a reinforced reaction function from the central bank was thus getting well established. The actions taken today are bold and multi-dimensional and should stand up to the task. The main ones pertaining to the bond market are as follows:
- Stronger forward guidance: For the first time, the MPC has introduced a time period to its guidance on accommodative stance. Thus while the commitment to this stance “as long as necessary to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward” has been made before, this time the committee voted to include specifying continuation with this stance “at least during the current financial year and into the next financial year”. Interestingly this guidance was voted for 5:1, with the dissent coming from new member Prof. Varma and not from the recently quite hawkish Dr. Patra. With this in place, the market is now comforted with respect to both the rates and liquidity stance of policy. This is important since some segments of the market had recently started to speculate with respect to the liquidity stance of the RBI. The clarity now provided will serve to firmly anchor front end rates. Embedded here is also the MPC’s clear assessment that the current episode of inflation is basis supply shocks which will dissipate and accordingly this can be looked through. This again is much needed and now removes the possibility that continued near stubbornly high prints on CPI can dislodge market expectation of “lower for longer” policy rates. Indeed, the MPC has kept the door wide open for further rate cuts as it awaits “the easing of inflationary pressures to use the space available for supporting growth further”.
- Renewed commitment to stable market yields: The RBI is stepping up single operation amounts under its open market operation (OMO) purchases to INR 20,000 crores from the INR 10,000 crores of OMO / twist that were being announced / conducted earlier. However, there is no clarity yet on the frequency of such operations with only the first such operation being announced for now. Furthermore, the RBI has also announced that it will conduct OMOs in state development loans (SDLs) as a special case during the current financial year. Amounts and frequency haven’t been mentioned here so far. Finally, the central bank has clarified that the enhanced HTM limit of 22% of NDTL for banks in respect of SLR securities acquired between 1st September 2020 to 31st March 2021 will be applicable till 31st March 2022. The move back to 19.5% percent will be executed in a phased manner starting from the quarter ending 30th June 2022.
- Further assured liquidity measures: A new on-tap targeted long term repo operation (TLTRO) has been launched to be available till 31st March 2021. This will be for tenors up to 3 years for a total amount of INR 1,00,000 crores. However, both tenor and limit can be modified depending upon feedback. The previous facilities of inclusion under HTM and dispensation from reckoning under large exposure framework (LEF) will apply here as well. Deployment can be to specified sectors and can take the form of bonds, money market instruments, or loans. Further, banks can pre-pay previously incurred TLTRO.
Assessment and Implications
The clearly defined monetary policy stance and assessment provided today are in line with our view that the current inflation is mostly an interpretational problem, and that policy will continue to be “lower for longer” to address the much larger issue of a once-in-two-lifetimes growth shock. Indeed, now market participants can look forward to the current or lower operative overnight rate for probably most of the next 12 months. Thus front end quality rates (AAA, sovereign and quasi sovereign up to 3 – 4 years) can be played emphatically for the carry and potential “roll down” that they provide. Similarly, this further enhances the appeal for our current preferred overweight stance on 6 – 8 year government bonds in our active duration funds (with the usual caveat that this can change depending upon evolving view).
The measures announced today should also serve to anchor longer end bond yields better than they have been in the recent past. To that extent the considerable steepening trend witnessed in the past few weeks may probably get arrested, at least for the time being. The unresolved question is whether there is potential for more than tactical gains at the long end. This is what needs further assessment on incoming data over the next few weeks. For now we are guided by our base case that the fiscal stress is real and multi-year, and that the RBI’s approach is to keep yields stable in the face of the extraordinary bond supply that needs absorption (including a very large expected Q4 SDL calendar), rather than to actively engineer a large rally in long duration bonds. As per this view, it has stepped up its intervention as yields stability started to get threatened, but may regulate this down the line if market appetite seems reasonable. Its stepping up to the plate is also timely given increasingly more divergence in monetary policy views in context of the rising re-opening optimism, as well as with the possibility of additional fiscal risks around the corner as the government contemplates its next stimulus measure.
Head – Fixed Income, IDFC AMC