The Reserve Bank of India on 8th February 2017 kept its key policy rate or the repo rate (which is the short term lending rate) unchanged at 6.25 percent for the second time in a row. This was against the consensus view in the market hoping for a 25 bps rate cut. All other rates i.e reverse repo rate, the marginal standing facility rate and the bank rate, were left unchanged.
Key things RBI noted
The RBI said that this decision of the MPC is consistent with a neutral stance of monetary policy with the objective of achieving consumer price index (CPI) inflation at 5 per cent by Q4 of 2016-17 and the medium-term (2 year) target of 4 per cent within a band of +/- 2 per cent, while supporting growth.
The RBI noted that while retail inflation measured by the CPI has come down for 5 consecutive months, this is driven mainly by deflationary price movements in food items (vegetables and pulses). However, the non-food , non-fuel inflation also needs to come down in order to achieve the target of bringing overall inflation below 5%.
Outlook regarding inflation
- The MPC is of the view that persistence of inflation ex-food and ex-fuel could set a floor on further downward movements in headline inflation and trigger second-order effects.
- For Q4 2016-17 headline CPI inflation is likely to be below 5 per cent.
- Favorable base effects and lagged effects of demand reduction due to demonetization may mute headline inflation in Q1 of 2017-18. Thereafter, it is expected to pick up momentum, especially as growth picks up and the output gap narrows.
- Base effects will reverse and turn adverse during Q3 and Q4 of 2017-18. Accordingly, inflation is projected in the range of 4.0 to 4.5 per cent in the first half of the FY and in the range of 4.5 to 5.0 per cent in the second half with evenly balanced risks on either side.
- The MPC noted three significant upside risks to the baseline inflation path – the hardening of international oil prices; volatility in the FX rate due to global market developments, which could speed up domestic inflation; and the effects of the house rent allowances (HRA) under the 7th Central Pay Commission which have not been factored in the baseline inflation path.
What it means
Most major banks cut their lending rates in January post demonetization and inflow of cash reserves. With this policy review from RBI, banks may not cut rates further for a while.
This was the RBI’s sixth bi-monthly and last policy for the year 2016-17 and the third by the Monetary Polciy Committee (MPC). The next policy meet will be on April 5-6.
Here is the press release from RBI.
The RBI released its fourth bi-monthly monetary policy statement for 2016-17. This was the first statement released under the new Governor, Urijit Patel. Things to note:
- The RBI cut the repo rate from 6.5% to 6.25%, despite the inflation forecast for fiscal 2018 going over target.
- The RBI also lowered its its real interest rate (i.e the nominal interest less the inflation) target to 1.25%, from the 1.5-2% band set by former RBI Governor Raghuram Rajan. This opens up room to cut rates further down the road.
- The RBI also indicated that the timeline for meeting its inflation target, has been stretched to end of 2021.
- Till now, a technical advisory committee used to advise the RBI Governor on monetary policy, but he wasn’t obliged to follow the advise. From now on, the policy interest rate will be “democratized” in some sense, via the Monetary Policy Committee (of which the Governor will be a member), which will decide the interest rates. This is because RBI was mandated from August ’16 onward to keep consumer inflation at 4% in the next 5 years with a margin of 2% on either side in the monetary policy framework agreed with the government.
Overall, the Governor has started his term on a dovish note. The yield on the benchmark bond fell from 6.773% to 6.732% on 4th October, and further fell to 6.674% by 5th October before recovering to 6.735%. The market expectation based of fallen yields (so far, 2016 has seen yields fall by 108 bps) is that there could be more rate cuts moving forward, coupled with RBI’s lowered real interest rate target.
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July ’16 Debt Market wrap up.
The yield on the 10-year benchmark (7.59% GoI 2026) ended the month of July at 7.16%. The yield on 10-year AAA Corporate Bond ended July at 7.82%. The theme over past few months has clearly been decreasing yields. The overnight rate ended at 6.59% at end July 2016 as against 6.96% 1 Jan 2016, while the INR closed at 66.69 July 2016 versus the USD as against 66.23 1 Jan 2016, a depreciation of 0.69%. While most global sovereign debt is trading at negative yields, and quantitative easing in Japan and Europe, high positive yields on Indian sovereign bonds makes them attractive to foreign investors. YTD, there has been significant improvement in India’s twin deficits (current account deficit and fiscal deficit), the currency outlook is relatively stable, and core inflation has been falling steadily since March 2014. Inflation might moderate even more thanks to a good monsoon. All these facts point to an expectation to more rate cuts by the RBI leading to higher expected yields. FII debt inflows are likely to be strong going forward, for both corporate and government bonds.
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