RBI hikes by 25 bps to 6.25% - First time since Jan 2014 RBI hiked the key policy rate by 25 bps to 6.25%, while maintaining the neutral stance of monetary policy. This is first hike since January 2014. Highlight of the policy was its neutral tone, while revising upward the inflation outlook and growing confidence about the economic growth. Going forward, we expect RBI to hike by 25-50 bps over FY19, unless the macro-indicators (domestic and/or global) deteriorate. Trends in Key Policy Rates and Benchmark G-sec Movement Our View: Time and again, the RBI has emphasized that its policy decisions will be data-driven. While in April policy, RBI had revised downward inflation projections for FY19, hi-frequency data prints and global developments since April 2018 suggests otherwise (See Annexure on last page). RBI hiked the repo rate in today s policy, while maintaining neutral stance (i.e. keeping all options open for policy decisions - given rise in volatility in global financial markets). Reasons for rate hike: Rise in headline and core inflation. High global crude and commodity prices. Significant rise in household inflation expectations. Closing Output gap - resulting in rising pressure on input and output prices. Increase in volatility in global financial markets - resulting in FPI outflows and thereby putting pressure on EM currencies.
At the same time, RBI has marginally revised upward the projections for the Economic growth. GDP is expected to be ~7.5%-7.6% y/y in 1H FY19 (Apr policy: 7.3%-7.4% y/y) & ~7.3%-7.4% y/y in 2HFY19 (Apr policy: 7.3% -7.6%) - on account of closing of output gap, revival of investment activity and robust global growth. RBI's Macro Outlook Macro - Variables 1H FY19 2H FY19 Risks Inflation 4.8%-4.9% y/y (Apr Policy : 4.7%-5.1% ) 4.7% y/y (Apr Policy : 4.4%) Upside : High crude oil prices, impact of revision in MSP prices, staggered impact of HRA revisions by various state governments, rise in households' inflation expectations, volatility in global financial markets Downside : Normal and welldistrubuted monsoon, adherence to fiscal deficit target by Centre and States Growth 7.5%-7.6% y/y (Apr Policy : 7.3%-7.4%) 7.3%-7.4% y/y (Apr policy : 7.3%-7.6%) Upside : Robust global growth, Revival of investment activity, swift resolution of distressed sectors under IBC, closing of output gap Downside : Geo-political risks, global financial market volatility, rise in trade protectionism Other Policy Developments: Increase in LCR carve-out from SLR ratio: Up to 2% of NDTL- thereby allowing banks to carve-out SLR up to 13% of NDTL). This will help in easing yields at shorter end of curve (which are already at peak levels). Regulation related to SDL valuations: As against current practice of uniform mark-up of 25 bps above the yield of G-sec of similar maturity, SDLs will now be valued in banks books at traded levels/ market levels and for nontraded securities, the valuation will be based on state-specific weighted average spread over the yield of G-sec of similar maturity. This will increase MTM losses for the banks. But to provide relief, the banks have been allowed to spread the MTM losses on investments held in Available for Sale (AFS) and Held for Maturity (HFT) portfolio for 1Q FY19 equally over next four quarters.
Market Reaction Post Policy: The Market Reaction was mixed at Shorter-end & Long end of the Yield curve. Shorter End of the Yield Curve POSITIVE: LCR Relaxation norms implies that it obliviates the additional 2% SLR requirement, thus freeing up ~ Rs. 2.4 lks crs for credit purposes. This will also help banks to reduce borrowing at the shorter end, thus thereby putting lesser pressure at the shorter end of the yield curve. Yields fell by 15-25 bps for 3 month assets & 10 bps for 6 to 12month assets. Longer End of the Yield Curve NEGATIVE: LCR Relaxation will lower the captive demand for bonds/slr Demand. Also MTM Valuation of SDLs will see incremental lower demand from banks in SDLs. Further, there was disappointment related to absence of any announcement for durable liquidity infusion measures (like OMOs). Yields moved up 7-8 bps across the 3 15yrs curve. Market View: Although the Repo rate hike was widely expected, the commentary from RBI was less hawkish. It also maintained its Policy Stance Neutral compared to broad market expectations of Withdrawal of Accommodation. The risks (Higher Oil prices & Higher UST yields) that we have highlighted in our previous notes, have already started to play out. This has been a clear point of concern as far as the RBI is concerned and which they have clearly highlighted in the policy document. Higher Oil prices not only affect Inflation, but also changes the Fiscal math as well as Current Account Dynamics & Balance of Payment Dynamics. With the current macro backdrop (domestic and international), we expect RBI to hike rate by 25-50 bps in FY19 depending on emerging growth and inflationary trajectory and future policy actions will be data-dependent. From a markets perspective, it is a given that the RBI will continue to be hawkish. The demand supply issue is clearly addressed by the Fin Min while RBI has done its part to allow spreading Bank losses over next few quarters as well as rationalizing FPI investment guidelines. Thus, it is just a question of time, when investors see relative value in bond yields vis-à-vis Cash. The underlying term premia (10yr GSec yields Repo Rate) in bond market are still near its historic highs. The state of the underlying economy & macro fundamentals doesn t warrant such pessimism in bond yields. Confidence will return to the market once the currency stabilizes and crude oil prices eases. Further with smaller weekly auctions being absorbed by investor appetite, we might see yields trade in narrow range. Also we expect Aggressive Open Market Operations (OMOs) from RBI (to the tune of Rs. 1,00,000 crs) in H2 FY 2019, and this will take care of any demand supply mismatches as far as G-Secs are concerned.
Market Yields and liquidity have already tightened in anticipation of aggressive rate hikes. There is excess fear pricing in the market yields. It s just a matter of time whether the underlying economy will remain supportive of the tightened financial conditions or the Rate markets will have to readjust itself to the growth revival. Our base case remains that of a very gradual increase in interest rates. On the yield curve, the 3-5 yr G-sec rates & 1-3 yr corporate bond rates are pricing in rate hikes and are more than compensating investors for it. There is significant protection build up in the current prices. Thus, we would run this segment as our Core portfolio, while longer duration would be tactically be added to the portfolio. The main risk to our view is from external factors like sharp rise in USTs, US Dollar strengthening and continuous rise in Crude Oil prices. We also expect bond yields to remain range bound from near term (3-6 months) perspective as market starts pricing in very gradual movement on policy rate action. Value buying shall emerge on every uptick in yields as spreads with respect to Repo rate are as high as ~250 bps for a 2 3 year AAA corporate bonds & ~ 175 bps for 10yr G-Secs. Rates View: We expect curve to steepen from medium to long term perspective. With the above view, we expect varying parts of the yield curve can fetch attractive returns over the next 6 12 months, albeit at various point of time. Current Rate Expected Rate (by March 2019) Repo Rate 6.25% 6.50-6.75% 10 year GSEC 7.85-7.95% 7.80 8.00% 10 year AAA Corp Bond 8.60-8.70% 8.75 9.00% 2-5 year AAA Corp Bond 8.50 8.75% 8.50 8.80% 2-5 year AA Corp Bond 9.20 9.50% 9.50 9.80%
Annexure : What has changed since April Policy Rising Inflation Significant rise in Household inflation Expectations Upward revision in inflation forecast by Professionals Professional Forecaster's Median projection for Quarterly Inflation(%) 1Q FY19 2Q FY19 3Q FY19 4QFY19 Headline CPI 5 4.9 4.4 4.6 (-0.1) (+0.2) (+0.4) (+0.3) Core CPI 6.1 5.9 5.5 5.2 (+0.6) (+0.6) (+0.6) (+0.5) Note : Figure in Paranthesis represents change over Apr policy V-shaped Economic Recovery Marginal Improvement in Consumers Rising US Treasury Yields Strong Dollar
Short comments on money market rates RBI hiked 25 Bps in line with general market expectation. RBI Increase in LCR carve-out from SLR ratio: Up to 2% of NDTL- thereby allowing banks to carve-out SLR up to 13% of NDTL is a big positive from the point of view of supply of CD. The pre policy market level was pricing in lot of fear of supply from banks. The increase in LCR carve out from SLR has now relieved the fear of issuances from banks. The short end of the curve will ease with reduced supply from banks. Banks especially private sector banks will have more liquidity to give credit. This will result in easy flow of credit to the economy. As the demand supply moves in favor of demand upto one year curve which had shot up will ease and levels may come down by 25 to 30 bps. The fear in market of RBI tightening liquidity has also eased as RBI has maintained neutral stance. This will work in favor of funds investing predominantly in up to one year assets. Source: RMF Internal Research, RBI, Bloomberg Disclaimer: The information herein above is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, affiliates or representatives ( entities & their affiliates ) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their affiliates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this document. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.