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Quantum View: Dovish RBI kept the door open for further monetary easing Friday, Oct 04, 2019

The Monetary Policy Committee (MPC) has once again cut the policy rates by 25 bps. This is a fifth consecutive rate cut with which the policy repo rate has been brought down by cumulative 135 bps from 6.5% to 5.15%. The decision for rate cut was unanimous though one out of six members voted for more aggressive 40 basis cut.

This policy decision was broadly in line with the market expectations though we find 25bps cut to be inadequate given the sharp downward revision in growth forecast. The RBI revised down its GDP growth forecast for FY20 from 6.9% to 6.1% noting weak domestic and external demand conditions and global uncertainties. While on the positive side, the RBI did acknowledge that “the continuing slowdown warrants intensified efforts to restore the growth momentum”.

The MPC also reinforced its accommodative policy stance and quoted “….to continue with an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target”. All in all the policy statement was reasonably dovish and kept the door open for further monetary easing.

On the inflation front the RBI has once again shown its comfort. Although in light of recent spike in food prices, they raised the Jun-Sep’ 2019 CPI projection by 30bps to 3.4% but retained the one year ahead CPI forecast at 3.5%-3.7%. The current surge in vegetable prices is transitory and is likely to moderate as winter supplies enter the market.

We believe the RBI is quite reasonable about their assessment of inflation as we still don’t see any material upside risks to the future inflation trajectory. Domestic demand situation is looking weak and most of the companies are cutting prices. Crude oil prices have come off and given the slowing global economy it seems unlikely to rise sustainably in near term. The government has reasonably high buffer of food grains. Monsoon has been good and reservoir levels are at multiyear high. The corporate tax cut can also have its own disinflationary effects.

Despite a rate cut and a dovish statement, the Bond market seems to be disappointed as there was some hope of deeper rate cut in this policy itself and much more aggressive tone from the Governor. The 10 year bond yield jumped over 8 basis point after the policy announcement.

We believe this selloff is transitory and bond yields may go down in coming months

From a long term perspective, we believe that the best in the bond market is now behind us. Nevertheless, from short term tactical perspective we do see value in long bonds at current levels and expect yields to come down in coming months as market starts pricing for more rate cuts and potential OMOs.

Given the likelihood of excess liquidity conditions, investors in money market, overnight and liquid funds should also expect lower returns as money market yields will fall with reduction in the Repo Rate.

We also continue to believe that the credit crisis which began in the bond markets in 2018 is not over yet and investors should continue to prioritse safety and liquidity over trying to earn high returns from bond funds.


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