The Monetary Policy Committee (MPC) kept rates unchanged (reverse repo rate at 3.35%, repo rate at 4%), and held on to its accommodative stance for “as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy”
However, the decision to maintain an accommodative stance was not unanimous this time. Prof Jayanth Varma expressed his dissent (we shall get details of his views in the Minutes of the policy on 20 August). Thus it was a 5-1 vote in favour of retaining accommodative policy bias.
We did see an increase in Variable rate reverse repo (VRRR) amount from Rs 2 tn to Rs 4 tn. Here again, while markets were expecting the amount at one go, the RBI has chosen a graded increase in the amount over next one month. Thus, a baby step towards liquidity normalisation has begun.
However, this should not be construed as an indicator of U-turn in rates. Even after increasing the VRRR quantum, the banking system liquidity continues to be in surplus mode. Hence, there is a high chance that the overnight rates may continue to hug the reverse repos rate in near term. So as a logical next step, we could see some more VRRR quantum increase in the October policy, but a reverse repo hike could be delayed at least till the end of CY 2021.
The RBI raised the CPI inflation forecast for FY22 sharply to 5.7% from 5.1% earlier. While markets were expecting an upward revision, key next to watch out for next few readings. While the RBI continues to maintain that current high inflation phase is a transitory hump, the full year forecast is just a shade lower than the upper end of their inflation range (6%)
On the market front we could expect the bond yield curve to flatten gradually (short end of the curve to move tad faster than the long end). For fixed income investors, focus should be to continue to build a high carry portfolio with moderate duration. The banking system core liquidity is still at Rs 10 tn and is unlikely to abate abruptly.
There is no case yet to exit fixed income strategies. Opportunity cost of being invested in liquid/overnight category funds is quite high as the steep curve provides carry advantage. Also, liquidity conditions despite VRRR increase is likely to remain comfortable. Floating rate instruments may gain popularity as markets position for a bottoming out of rate cycle.
Till then the slogan is likely to be …” Rate hike another day…economic growth yet has to play….”
Disclaimer: Views are personal and do not reflect the views of Kotak Mahindra Asset Management Company Limited.
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