Systemic liquidity has been improving significantly in recent times and there is every reason to hold that the process of moving to a structurally positive liquidity situation is going ahead as planned by RBI.
RBI is announcing its credit policy on 4th October and some interesting aspects are attached to this interaction. However, before we delve into it, it is important to view the backdrop against which the policy is being announced.
The macro-economic environment of India is significantly better than what it was in 2011-12. There is a robust process of government clearances and clarity in policy across various sectors. In addition, rural wages are funded by sources other than MNREGA and we expect 7th pay commission to add to the domestic demand in the coming quarters. However, there continues to be a general slackness in industrial output, especially in manufacturing and demand for private capex remain subdued. Industrial capacity utilization remains a tad weaker at around the 75% mark. There is a need to revive private spend as government spend which has, till now been robust, is bound to slacken as we move towards reducing fiscal deficit. India continues to show strong economic growth with estimates for GDP growth during FY17 being in the habitat of 7.8%. India retains its slot as one of the fastest growing emerging markets.
We have seen CPI softening significantly recently on the back of relatively good monsoons and expectations of robust sowing are lowering inflationary expectations. Domestic reservoir levels have been steadily increasing and stand at around 75% to 80% of the peak capacity mark. In this backdrop, we expect CPI to dip below 5% in the coming months and remain within RBIs inflation trajectory for the coming quarters. Systemic liquidity has been improving significantly in recent times and there is every reason to hold that the process of moving to a structurally positive liquidity situation is going ahead as planned by RBI. Crude oil prices have been relatively low and stable for a while now and experts see it remaining so for a while. INR has been relatively appreciating vs USD (albeit with a few spikes).
Based on the macro outlook, there is reason to hold that RBI may engage in a repo/reverse repo rate cut to the tune of 25 basis points. RBI may hold other reference rates steady for now. Some concerns remain though – we have a new governor and we are also transitioning to a Monetary Policy Committee structure which is a relatively untested model in the Indian monetary policy framework. Additionally, some concerns exist relating to the FCNR repayments and the volatility in INR and liquidity which may accompany it (though we think the impact may be short term in nature). Some concerns relating to the FOMC hiking rates in USA are also weighing on investors. There remains an outside chance that RBI may hold back cutting rates for now. There may be a momentary correction in that case before the markets pull back on rate cut expectations in the coming policy. In that case, market participants may be keen to hear RBIs views to gauge its rationale for holding back for now.
However, irrespective of the rate action, we may hope to see a benign stance from RBI. We may expect RBI to reiterate its commitment to provide the market with adequate liquidity and watch the inflation trends closely. RBI may continue to analyse incoming data at a granular level to nuance its policy actions. Some mention of international and India related geo-political risks may also find mention in RBIs monetary policy statement. RBI may reiterate its advise to banks to reduce lending rates and ensure a better transmission of monetary policy actions.
With softening inflation and robust liquidity, we expect the benchmark 10 year GSec to trade in the range of 6.75% to 6.90% for now. We retain a positive outlook on domestic bond markets and believe that investors with a medium to long term investment horizon can invest confidently in Indian bond markets.
The author is head- fixed income at Peerless Funds Management Company