As the yields rise in US, will the RBI’s ‘contrarion’ stance put it behind the curve?

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The meteoric rise in the 10 Year US Treasury bond yields continued unabated as they breached the important 2 percent mark on February 10. The US federal bank has shown hawkishness in its policy stance towards rising interest rates and tightening of liquidity as the US inflation continues its march northwards. The rising bond yields are resulting in a continued pull out of foreign funds from the emerging markets.

However, back home, the Reserve Bank of India (RBI) in its monetary policy committee meet yesterday, continued its “accommodative stance” stating that “continued policy support is warranted for a durable and broad-based recovery”.

Is the RBI falling behind the curve?

Sometimes markets expect dessert, but then realise that the main course is still not over.

“The market was broadly expecting a drawdown of ultra-accommodative monetary policy by a partial restoration of the repo-reverse repo rate corridor, with some even expecting forward guidance on further monetary policy normalisation” said Aurodeep Nandi, India Economist and Vice President at Nomura.

Instead the RBI surprised by not only doubling down on its now familiar orthodoxy of keeping rates and stance unchanged, but also expressed a very dovish outlook for inflation for FY23, forecasting it at 4.5 percent.

It is of the opinion that the inflation is largely driven by the base effect in the near term and given the benign outlook on food inflation, it doesn’t have any serious concerns on this front.

“This comes despite higher oil and commodity prices, growth-supporting fiscal policy, continued economic normalisation, and a distinctly hawkish Federal Reserve. This suggests that the RBI is likely to remain behind the curve, until macro circumstances warrant a shift of gears”, added Nandi.

V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services, was of the opinion that, “even though this ‘accommodative stance’ of RBI might invite criticism of the central bank being behind the curve, this clear pro-growth stance is desirable at the current juncture”.

RBI pins hopes on inflation forecast to continue accommodation in FY23

RBI has also put forward its moderate view on inflation and has persisted with its average forecast of 5.3 percent for CPI inflation in the current year despite the headwinds from high crude oil prices.

Is there a fear of excessive fund outflows?

Investment bank Merill Lynch said in a report earlier this week, “the effect of the ongoing pandemic, a Fed that has made a hawkish pivot, a stronger U.S. Dollar, and high oil prices all may pose significant headwinds for international markets, especially EM. Within EM there is also concern over China growth moderating and what the effect of “zero-covid” policies may be”.

Investors will also look to the pace and commitment to policy easing by the People’s Bank of China as a potential positive. “For now, while these crosscurrents and a backdrop of heightened geopolitical tensions play out, we maintain our strategic weighting to both International and EM Equities”, the bank said.

Overall, RBI has consciously taken a different stance on its monetary policy vis-à-vis the other key central banks by persisting with the accommodative stance on the expectation that inflation will remain relatively moderate in India till growth and demand signals become strong and durable.

RBI survey shows consumers remained pessimistic about present in January, but inflation expectations slumped

“On liquidity front the RBI has already tightened the grip and squeezed the substantial amount from the system through Variable Repo Rate (VRR) and further indications are clear that RBI will continue with the accommodative stance on rates for an extended period and in second half of the FY 23 we can see some action from the RBI on rate front” said Deepak Panjwani, Head-Debt Markets, GEPL Capital.

Last but not the least, “staying put” is the best strategy when in doubt. “The complete status quo in the RBI policy, when the things have changed so much since the last policy statement, signals a banker in doubt and not a confident policy maker as the governor has pretended to be” said Amit Kumar Gupta, portfolio adviser at Adroit Financial Services.