Forbes India – Economy, Interest rates: RBI Monetary policy: too much at stake

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Indian 10-year bond yields have climbed relentlessly. They are close to their highest levels since July 2019
Image: Shutterstock

Jhe Reserve Bank of India’s (RBI) upcoming monetary policy meeting, due to be announced on Feb. 10, has gained prominence due to a series of economic issues that need to be addressed. India’s wholesale price-based inflation has been in double digits since April 2021 and needs to be brought under control, even as Governor Shaktikanta Das says the bank has remained “accommodative” in its policy to try to revive and support growth , as India emerges from the impact of the pandemic.

But, on the other hand, Indian 10-year bond yields have climbed relentlessly. They are near their highest levels since July 2019 (see chart), spooked by the global tightening of central bank liquidity, rising inflation concerns and an increase in the government’s borrowing program, as announced in the fiscal year 23 budget. Higher bond yields not only put pressure on interest rates, but also drove up lending rates.

Das will be heard loudly by the market on inflation, the rate trajectory for 2022, the bank’s stance on growth and the message to the bond market. The market will also want to hear comments from the RBI in a scenario where several central banks have started to embark on a tightening of liquidity measures.

In late January, the US Federal Reserve said it would soon raise interest rates for the first time in three years. The Bank of England this month raised rates for the second time in three months and the European Central Bank dropped its stance on not raising rates in 2022, while acknowledging inflation risks. “Global liquidity tightening, the US Fed turning hawkish, rising inflationary concerns across economies and increased government borrowing are the reasons for higher yields,” says Devang Shah, co-head of income securities fixed at Axis Mutual Fund. .

Change of political orientation?

The RBI is unlikely to increase the repo rate, but it could increase the reverse repo rate (the rate the central bank pays banks when they deposit their excess cash into it). The reverse repo rate has remained unchanged at 3.35% since May 2020. The gap between the two rates is now expected to normalize soon.

But will the RBI signal the end of its dovish stance and turn neutral? Minutes of the latest RBI policy meeting revealed that all members of the Monetary Policy Committee (MPC), except Prof Jayanth R Varma, voted to maintain the dovish stance for as long as necessary to revive and support growth. The jury is out, but experts we spoke to suggest he’s likely to be flagged in the coming policy.

Nomura India’s Business Resumption Index rose to 113.2 for the week ending Feb. 6 from 104.8 the previous week, indicating 13.2 percentage points above the pre-pandemic level. All critical elements such as mobility, activity rate and electricity demand increased week by week. “The improvement is indicative of the third wave decline and declining public risk perception…” analysts Sonal Varma and Aurodeep Nandi said in the note to clients.

“The RBI, in its monetary policy, needs to move from accommodative to neutral and then tighten. But this needs to be done in a synchronized and calibrated manner,” says Dhawal Dalal, Chief Investment Officer, Fixed Income, Edelweiss Asset Management. Shah d ‘Axis also suggested that there is a “50:50 probability of a change from RBI’s dovish stance to neutral.”

The change in stance could also signal when the RBI will start raising rates and show how worried the RBI is about fighting inflation. The WPI fell slightly to 13.56% for December 2021 from 14.23% in November as minerals, oil, food and natural gas fell, but remains in double digits for the ninth consecutive month. The RBI expects the Consumer Price Index (CPI), which was 5.59% in December, to rise to 5.7% for FY22. already warned of the risk of “imported inflation” due to high global energy prices, with crude oil testing the $95 a barrel mark this week.

Will the RBI continue to flag the Omicron variant as a concern even though new cases and the positivity rate have dropped in Mumbai and Delhi? This seems likely and with growth expected to be uneven for the next 12 months, the central bank is unlikely to raise the repo rate at this week’s policy meeting. The economic survey pegs India’s GDP for FY22 at 9.2% from a low base and at 8-8.5% of GDP for FY23. Most economists and Financial institutions forecast India’s growth of between 7.8 and 9%.

Comfort the bond market

Das has another job to do, comfort the bond markets. Bond yields typically drive interest rate hikes and have risen over the past six months. Much of the negatives have already been priced in, but the RBI cannot afford yields to continue to push north. “The RBI should lead by example, it should comfort market forces. They can’t let yields fly away,” says Dalal of Edelweiss AMC. Last year, the RBI bought government securities through open market operations (OMOs) to cap yields.

US Federal Reserve Chairman Jerome Powell said in January that he would soon normalize policy by ending interest rates in 2022 and phasing out his asset purchase program faster than expected. by March 2022, to support the economy. Powell said “several” rate hikes could be expected and a Reuters poll showed three hikes in 2022.

Another concern is rising crude oil prices which, as it nears the $100 a barrel mark, could cause huge pain for India. India meets about 85% of its crude oil demand through imports. This price spike is not only hurting “import inflation,” but could also threaten to derail fiscal deficit targets, if more borrowing is needed. All of this led to a further rise in bond yields.

With macro concerns growing after global central banks announced liquidity tightening measures, local sentiment also soured. In the FY23 budget, the government announced a gross borrowing of Rs 14.95 lakh crore for the year ending March 31, 2023, compared to budget estimates of Rs 12.05 lakh crore for the current period of exercise 22.

In another development, India expects to be included in global bond indices, a move that Morgan Stanley Research said was “imminent” in a report last October. If this inclusion takes place, it could attract more than $170 billion in bond inflows into India over the next decade and reduce borrowing costs. The report predicted that India would be included in two of the world’s three major bond indices by “early 2022”, its chief Indian economist, Upasana Chachra, said.

The move would trigger index-linked inflows and allocations from global bond investors, and help companies gain better access to capital and drive demand for other corporate fixed-income securities. But that has yet to happen and has clouded the mood in the bond market.

“The next monetary policy committee meeting will be held in the shadow of the FY23 budget, which rightly maintained its growth target, but at the expense of high market borrowing,” said Churchil Bhatt. , Executive Vice President (Debt Investments) at Kotak Mahindra Life Insurance. “At the next meeting, the MPC will likely recognize the inevitability of policy normalization and the challenges we face as global central banks step up their fight against inflation,” Bhatt said.

Bhatt, like other pundits, expects reverse repo rates to rise at the February policy meeting and thereafter the MPC will change its dovish stance to neutral. “With policy normalization underway, RBI support for bond markets is likely to remain limited going forward, even if headline inflation remains within the RBI’s target range. As harsh as that may be, [the] RBI will have to juggle non-disruptively between its policy normalization goals and the management of the government’s borrowing program in FY23.”

Eye Passive ETF Debt Funds

Another issue that worries bond markets is that many of the estimates for growth, fiscal deficit and inflation come with caveats, not clear convictions. The FY23 budget deficit, pegged at 6.4%, is expected to rise, hurting sentiment.

“Politicians and decision-makers speak of the hope that the third pandemic wave is weakening; that crude oil prices do not increase further and that more allocations should not be made to MNREGA. There is no clear valuation and that scares investors more,” said a bond analyst at an equity research firm.

With so many moving parts and RBI clarity likely to emerge over the next two policy meetings, fund managers are advising potential debt investors to look to passive exchange-traded debt funds (ETFs). These would be cheaper than actively managed funds; it would also be more prudent to be patient and to invest in several tranches in funds with a medium to long duration.

Any rise in interest rates will mean that the value of existing debt instruments could fall, as higher interest rates will attract more investors to new debt funds that offer higher interest rates.

ETFs were the most popular fund category for investors in 2021. This category had assets worth Rs 3.84 lakh crore in 2021 compared to Rs 3.61 lakh crore for liquid funds, data shows. by Crisil. Several new asset management companies have in recent months launched various passive debt ETFs, at a time when the timing and double estimation of market and index movements has become more difficult. So while equity-focused mutual funds might have posted better returns thanks to record highs in the market, the average alpha of actively traded funds continues to decline.

This brings the focus back to how the RBI will react to the changing global macroeconomic environment and tightening central bank liquidity.

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