Churchil Bhatt
There is a complete lack of buzz in the bond market when it comes to the upcoming monetary policy decision, with consensus for another one of those predictable, status quo policies. But predictable lacks excitement, predictable is boring. Yet, predictability is what policymakers often aim for, and rightly so. Anyway, at least for the time being, the narrative driving bond yields in India is anything but policy rates.
James Carville’s rather popular catchphrase of 1992, “It’s the economy, stupid.” was meant to direct the voter’s attention towards the recession in their economy. The situation today is diametrically opposite, locally and globally. Clarion calls of global recession have sunk into oblivion. So much so that the most widely anticipated US recession may not ever arrive. Germany, the UK and a few other economies flirted briefly with negative growth but failed to get much attention. Uncle Sam’s economy, on the other hand, is growing strong, almost oblivious to the Federal Reserve’s restrictive monetary policy.
There is also a case of global inflation reacting a bit too slowly to central bank tightening, especially on the services side. Over the last couple of months, the world has discovered that the last mile in the fight against inflation is a long-drawn one. Consequently, prospects of rate cuts have been delayed, though not yet derailed. As a result, we have witnessed lots of volatility in global bond yields, but not so much in India.
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There are economies in the world with far weaker growth than India and yet their policymakers are not yet ready to cut policy rates. Against this backdrop, it seems unlikely that India will lead the way into policy easing. We are experiencing, what many believe, to be a prolonged phase of healthy economic growth. 8 percent GDP may be a one-off statistical peculiarity, but let that not draw our attention away from a healthy 6.5 percent GVA. And this growth is in the aftermath of a rate tightening cycle by the Reserve Bank of India (RBI). Add favourable demographics, buoyant credit growth, resilient capital flows and expectations of a stable government to the mix and there is hardly a case for immediate policy easing.
Bond market optimism
On the other hand, the current repo rate of 6.5 percent in combination with the Monetary Policy Committee’s (MPC) FY25 average CPI projection of 4.5 percent leaves us with a rather restrictive real rate of 2 percent. Consistent fall in both headline and core inflation gives room for some measured policy easing sometime during FY25, if not immediately. Given this limited room for optimism, one may find that the bond market in India is trading at somewhat rich valuations. If it isn’t the economy, what else explains this bond market optimism?
The answer to the puzzle lies in supply-demand imbalance. First, there is India’s inclusion in the JP Morgan Global Bond Index beginning in June 2024. This alone is expected to result in an additional demand of more than $25 billion of government bonds by foreign investors. Compounding the joy, the FY25 interim Budget was a pleasant surprise for Indian bond markets.
The government of India’s accelerated pace of fiscal consolidation plan means that the gross supply of government bonds in FY25 will be lower by Rs 1,30,000 crore than the same in FY24. Given that this demand-supply mismatch was created during a narrative of a “peak in global policy rates”, it resulted in a surge in demand for duration (longer tenor bonds). Thus, in the case of India, the disappointment of delayed policy easing has been more than offset by favourable supply-demand dynamics.
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We expect no change in policy rates in the April MPC meeting, with the members continuing to adopt a ‘wait and watch’ approach. Our growth and inflation are both on the right trajectory. Early indications suggest a normal monsoon, which, if true, will keep food prices well behaved.
Recently there has been some upward pressure in global commodity prices, that the members may want to keep a close watch on. At the current juncture, we do not foresee any major energy price shocks, though such things rarely happen with advanced notice.
All in all, the MPC may want to assure itself of the durability of a 4 percent inflation target and wait to assess the policy actions of major global central banks. For forward guidance, market participants will closely watch out for the committee’s views on prevailing real rates.
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The writer is Executive Vice President & Debt Investments, Kotak Mahindra Life Insurance Company
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