In a James Bond-inspired Die Another Day-style, Bond Street was greeted by a ‘Hike Another Day’ MPC (monetary policy committee) outcome. The Reserve Bank of India’s MPC chose to keep all key rates unchanged, though a section of the markets (including us) were expecting an outer chance of 15/20 bps hike in the reverse repo rate. While the vote was unanimous, the accommodative stance was dissented by one member, hence a 5-1 vote.
Real GDP growth in FY2022 was maintained at 9.5 percent, so was the headline CPI (consumer price index) forecast at 5.3 percent. The liquidity normalisation process, which is under way, got a further fillip, with an increase in the quantum of the 14-day variable rate reverse repo – VRRR – from Rs 6 trillion to Rs 7.5 trillion) in a graded manner. We view the policy stance as dovish without signals of any reverse repo rate hike or any explicit liquidity withdrawal measures.
The RBI continues to remain cautious on growth, which is logical given the global developments due to pandemic concerns. With no material tweaks on the headline inflation front as well, it reinforces our view of being mindful, not paranoid, on the inflation front.
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While VRRR continuity was on expected lines, it clearly signals the RBI’s intent to continue with liquidity normalisation. We could expect short-term rates to readjust higher in the coming weeks. From January 2022, liquidity management shifts to the auction route, though no mention of tenor was made. We view this as a precursor to realign overnight rates closer to the repo rate. All the above point toward the yield curve flattening – something which we have been stating for a while now.
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For now, we expect bond yields to trade rangebound in the absence of imminent near-term triggers. Among the key events to watch out for is the glide path to index inclusion for Indian bonds. As we get clarity on the same in the coming months, it could act as potential bait for FPIs (foreign portfolio investors) to make some allocations to India fixed income. Global cues are likely to gain prominence as bond yields gyrate to moves in global yields (UST specifically).
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What’s in it for fixed income investors?
With rates bottoming out and the rate hike cycle yet to manifest itself, carry trade will continue to be the dominant theme in fixed income. The pace of tightening and/or liquidity normalisation is a more gradual process, which means investors could continue to stay invested across the yield curve. The current yield curve is reasonably steep, offering enough reason for investors to stay put. There may be volatility, no doubt, but the key is to map one’s investment horizon, risk appetite to the portfolio duration and its constituents. This way, one is not tempted to exit at the first sign of market fluctuation. Market yields tend to adjust itself sooner than traditional modes of investments can re-price their offerings. Hence, it may be prudent for investors to diversify their fixed income allocation across suitable mutual fund schemes.
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