Monetary Policy | RBI poised for more easing; bonds volatile with a dovish bias

Siddhartha Sanyal

The Reserve Bank of India (RBI) will likely continue lowering interest rates further over coming months, including in the monetary policy committee (MPC) meeting in August. After raising the repo rate by 50 bps (basis points) during 2018, the MPC has delivered three consecutive rate cuts of 25 bps each so far during 2019.

Taking into account the current macroeconomic backdrop, the central bank is expected to lower the repo rate by another 50-75 bps over the course of the remaining eight months of FY 19-20 (August-March), of which a 25 bps cut will likely be delivered on August 7.

The MPC changed the stance from ‘neutral’ to ‘accommodative’ in June. The stance of monetary policy looks set to remain accommodative in months ahead.

Benign inflation, sluggish growth suggest more easing

The evolving growth-inflation dynamics supports the case for further easing. Headline CPI inflation remains low, undershooting the RBI’s target of 4 percent for several months and averaging sub-3 percent YoY (year on year) over the past six prints. Core inflation (CPI excluding food and energy) remains soft, offering strong cushion for inflation expectations. Rainfall had been erratic so far during the monsoon season. That might push up prices of food items (perishables, in particular) in the near term.

However, on the basis of more fundamental demand-supply trends for various agro commodities and other food items, such spikes in food prices are expected to be short-lived. Food inflation in the last about five years had mostly been benign despite spells of weather shocks. Oil prices have remained largely benign, notwithstanding occasional bouts of volatility – the latest Brent crude oil price close to $60 per barrel remains a source of comfort for monetary management.

Growth momentum, on the other hand, has weakened materially of late  with Q4 FY19 (January-March) growth coming in at a markedly weak 5.8 percent YoY. GDP growth in the subsequent print (ie., Q1 FY20) can weaken further and a host of lead indicators have not displayed any meaningful recovery subsequently. Growth momentum remains somber for a host of other countries and several central banks have again turned dovish in recent months.

Bonds volatile with a dovish bias

Bond yield of late has been volatile – 10-year Indian government bond moved within a relatively wide range of 6.30-7.10 percent over the last two months and currently stays at around 6.40 percent. It is expected that bond yield will likely continue to be volatile within a range of 6-6.60 percent -- or modestly wider -- with a dovish bias in the near term.

Accordingly, bond yield towards the upper end of this range will often offer a buying opportunity, in my view, in the near term. On the other hand, there is a case to turn more cautious on bonds if the benchmark 10-year yield softens close to or beyond 6 percent.

Fiscal slippage, monsoon, FII sentiment key risks

As discussed above, the bond market currently enjoys the tailwind of a number of positive factors (eg., favourable growth-inflation dynamics, rate cuts by the RBI and a broadly easy liquidity scenario). Such factors – especially fresh signs of weak growth and the possibility of multiple repo rate cuts in days ahead – will likely remain the dominant theme for the bond, which will maintain a dovish bias in the near term.

However, the market will not be able to ignore a set of concerns as well. For instance, risks of fiscal slippage during 2019-20 continue to weigh on market sentiment. Foreign institutional investors (FIIs) have also curtailed their investments in Indian assets in recent weeks. Possibility of an erratic monsoon pushing inflation materially higher remains another worry. CPI inflation will also reflect a markedly adverse base effect towards the end of 2019.

Overall, such risks might trigger bouts of uncertainly and volatility for bonds as well despite the near-term dovish bias.

The author is chief economist and head of research at Bandhan Bank. Views are personal.