The suspense has finally ended and the Monetary Policy Committee (MPC) has announced its verdict. The status quo decision on rates doesn’t come as a surprise to bond markets.
However, the series of other measures announced is indeed commendable and is definitely a pre-Diwali Dhamaka for bond markets.
The key to policy decision was to see if the MPC would resort to some untested/unconventional measures and indeed "walk the talk".
On that account, we must commend the RBI as they have offered reasonable clarity on the way forward, apart from a series of market-friendly measures.
For starters, they announced on tap or targeted long-term repo operations for the maturity of up to 3 years with a total limit of Rs 1 trillion at rates linked to policy rate up to FY20-21.
This is a very good move to offer extended liquidity to the banking system. This can act as a catalyst for spread compression in corporate bonds, especially in the non-AAA segment.
Additionally, the dispensation in statutory liquidity ratio (SLR) holding in held to maturity (HTM) investments to 22% of NDTL (Net Demand and Time Liabilities) has been extended up to March 31, 2022 (from March 2021).
Again, this helps bolster the demand for central government bonds at a time when credit growth is tepid, while deposit growth continues to be robust.
While OMOs (Open Market Operations) in central government loans were a market practice, the RBI said they would conduct OMOs in state development loans (SDLs).
The spreads of state loans v/s central government loans had widened abruptly with the markets reeling under supply pressure. This move is a bazooka and will see SDL spreads cool off meaningfully.
In the case of central government bond OMOs, the amount has been enhanced to Rs 200 billion from the earlier Rs 100 billion.
It seems like there could be a move from sporadic OMOs to more periodic OMOs. This would go a long way in anchoring yields at current levels with an easing bias.
In our view, markets will gather a lot of confidence from RBI’s decision to retain the accommodative stance at least through the end of FY2021 and into FY2022.
The MPC’s decision to look through the current inflation as transient and address the more urgent need to revive growth and mitigate the impact of COVID should also aid market sentiments.
While a rate cut in the December policy remains unlikely given the high inflation rate, a rate cut in the February 2021 policy would remain contingent on how inflation evolves towards the end of the year.
For fixed-income investors, there is a strong case to stay invested with carrying and potential capital gains providing a solid rationale to stay invested. While yield movements may be range-bound, the ranges are likely to keep shifting southward.
This truly makes a case for market participants to look up and say ‘..Mogambo Khush hua…’
Stay safe..stay invested…
(Lakshmi Iyer, CIO (Debt) & Head – Products, Kotak Mahindra AMC)
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