The Reserve Bank of India (RBI), in its first bi-monthly Monetary Policy Committee (MPC) meeting for FY19-20, decided to cut the policy repo rate by 25 bps from 6.25% to 6%.
Consequently, the reverse repo rate stands adjusted to 5.75%, and the marginal standing facility (MSF) rate and the Bank Rate to 6.25%. The MPC also decided to maintain the monetary policy stance as neutral. RBI also announced liquidity easing measure by permitting banks to count an additional 2% of Government Securities within the mandatory SLR requirement for the purpose of computing liquidity coverage ratio, in a phased manner.
The rate cut and neutral stance was on the expected lines. MPC members were divided on the policy rate action, with Chetan Ghate and Viral Acharya voted again, as in the previous policy, to keep the policy rate unchanged.
RBI has been repeatedly making downward revision to both inflation and growth numbers. Headline inflation for H1 2019-20 in December policy was projected in the range of 3.8% - 4.2% which was revised to 3.2% - 3.4% in February policy and is now changed to 2.9% - 3% with risks broadly balanced. GDP growth for H1 2019-20 was earlier projected at 7.5%, which was revised to 7.2% - 7.4% in February policy and is now changed to 6.8% - 7.1%.
Several factors provided MPC room to go ahead with another rate cut of 25 bps including consistent fall in food prices, benign food inflation outlook, expectation of normal monsoon, lower growth rate projection, widening of output gap with increased headwinds from a slow down in the global economy.
Our view
RBI delivered 25 bps policy rate cut as expected, though a segment of market was expecting 50 bps rate cut. With this cut, RBI might take a pause for couple of MPC meetings and wait for more clarity on monsoon, outcome of general elections, crude oil prices, sticky core inflation and inflationary impact due to any additional fiscal slippage. Although, the rate cut would benefit the economy, however, inefficient transmission of rate cuts has led to partial and delayed reduction in weighted average lending rate (WALR) of banks. RBI has expressed concerns regarding this issue and is working towards ensuring better transmission.
On the growth front, lead indicators such as auto sales, manufacturing and services PMI, air passenger and freight traffic, business confidence index, cement production and steel consumption are giving mixed signals. Increased credit offtake amid rising capacity utilization would provide support to the GDP growth, whereas global economic slowdown may dampen domestic growth prospects.
Over the past few months, long term bond yields have witnessed a sharp drop from levels of 8.15% (10-year G-Sec) to 7.32% (after today’s policy announcement), in line with lower inflation prints and fall in crude oil prices. However, increased market borrowing via central/state government securities and T-bills for FY20 along with reduced OMO purchases in coming months (potentially due to the success of dollar swaps being conducted by RBI) and concerns over fiscal slippage may put some pressure on long term G-sec yields.
Recent data suggests that short term (3 to 5 year) corporate bond spreads have come off from their recent highs and are trading near their long term averages, particularly the AAA & AA rated universe. Whereas, A rated corporate bond spreads are still trading at one standard deviation above their long term averages indicating that concerns over defaults / downgrades and liquidity tightness in the credit market have not yet subsided. One needs to be mindful of the current stress in the credit market and stick to high credit quality banking and PSU bond funds and short-term corporate bonds funds from a risk-return perspective. Based on our assessment, the overall yield curve, across short, medium and long term tenors, has started to look attractive due to high real rates and we’re evaluating suitable strategies within these categories.
