Oct 10, 2020
In line with market expectations, the newly appointed Monetary Policy Committee (MPC) in its first meeting today, October 09, 2020, decided to keep rates unchanged, while deciding to maintain accommodative stance for as long as necessary to revive growth on a durable basis. To support the financial markets the RBI announced measures to provide liquidity. The RBI also announced regulatory support to improve the flow of credit to specific sectors, boost exports, deepen financial inclusion and facilitate ease of doing business by upgrading payment system services.
RBI’s Assessment of The Economy
• Global economic activity appears to have rebounded sequential in last quarter, though the rebound is uneven across economies.
• Locally, several high-frequency indicators are showing signs of rebound after a sharp contraction.
• Rural economy looks resilient with good Kharif sowing, good monsoon and job creation due to MNREGA providing support.
• Economic recovery is likely to be a three-speed recovery. Sectors like agriculture, FMCG, auto, pharma are likely to show first signs of resilience, followed by sectors where activity is normalising gradually, and finally contact-intensive sectors would recovery.
• Inflation has been above RBI’s tolerance band because of supply side shocks and hence can be looked through at this juncture. Inflation is likely ease gradually towards RBI’s target over Q3 and Q4 FY21.
• The CPI inflation is projected at 6.8% for Q2 FY21 and at 4.5-5.4% for H2 FY21. The RBI had refrained from giving an inflation outlook in its last few MPCs.
• Prices of key vegetables are likely to reduce in this quarter with the arrival of kharif harvest, while prices of pulses and oilseeds are likely to remain elevated due to import duties.
• Progressive easing of supply side constraints will help reduce cost-side inflation pressures.
• GDP growth in FY21 is projected at -9.5%. GDP growth is likely to improve through the year with Q2 FY21 growth projected at -9.8%, Q3 FY21 at -5.6% and Q4FY21 at 0.5%.
• Rural economy to recovery quickly, while urban demand is likely to take more time to recover.
• Liquidity Measures
o OMOs in SDLs – As a special case, the RBI decided to conduct open market operations (OMOs) in state development loans (SDLs). This is likely to improve liquidity and help in absorbing expected increase in supply of SDLs.
o On tap TLTRO (targeted long-term repo operations) with tenors of up to 3 years for a total amount of up to INR 1 Lakh Crores.
o SLR holdings in HTM – Enhanced held to maturity (HTM) measures announced by RBI earlier extended till Mar’22 from Mar’21 earlier.
• Regulatory Measures
o Higher credit limit to retail borrowers as limit increased to INR 7.5Cr from INR 5Cr earlier.
o Rationalisation of risk weights on individual housing loans to link them to LTV ratios for loans sanctioned up to March 31, 2022
• Co-lending model where banks and NBFCs co-originate a loan extended to all NBFCs.
• Round the clock availability of RTGS – RTGS to be made available round the clock on all days from Dec’20.
As a consequence of lower economic activity this year, revenue collections have been hit and a higher fiscal deficit has been widely expected. Therefore, fixed income participants have been anticipating higher borrowing by the government. This was apparent in the devolved auctions as well as in the rejection of all OMO bids by the RBI. Earlier last week, however, the RBI announced an unchanged borrowing target of INR 12 Lakhs for the year. The bond yields hardly reacted though, signalling that the market didn’t believe in the fiscal math. SDL yields on the other hands moved up sharply as market expected higher borrowing from states to bridge the fiscal gap.
Today’s announcement of OMO in SDLs as well as the overall dovish tone surprised markets. Bond yields reacted positively to this announcement and headed lower (8-10 bps) quickly. We think the move is largely captured and while there may be some more marginal compression, the risk-reward isn’t in favour of taking a duration call from hereon. Hence, we continue to be neutral on duration and continue to recommend ultra-short bond funds for the time being as we scoot for attractive debt investment opportunities.