Views on RBI Monetary Policy & Debt Market Outlook

Rahul Goswami, CIO- Fixed Income, ICICI Prudential AMC

The Reserve Bank of India (RBI) left its key policy interest rates- repo rate under LAF unchanged at 8% &CRR unchanged at 4%; however, the bank reduced the Statutory Liquidity Ratio (SLR) by 50bp to 22.5% of banks’ net demand and time liabilities (NDTL), from 23% previously. Apart from this, there was marginal tinkering on the liquidity provided to the banking system on a daily basis, whereby the export credit refinance has been reduced from 50% of outstanding to 32% of outstanding; RBI compensated this availability of liquidity by introducing a special term repo facility for equivalent amount which is roughly 0.25% of NDTL.

We see this policy dovish against the previous policy, where RBI had highlighted that if the disinflationary pressures in the economy continue to perform and inflation moderates faster than anticipated, RBI would have room for monetary easing in the system. Taking cognizance of the fact that CPI inflation (ex. Food & energy), has moderated but is still elevated as per RBI’s target, the repo rate has been kept unchanged. There are concerns regarding El Nino, which may impact the monsoon, and inturn the food inflation but the risk to RBI’s medium-term target of CPI inflation- 8% by Jan2015, and 6% by March2016, is likely to be balanced by government’s efforts towards fiscal consolidation and better food supply management.

RBI highlights that growth remains sluggish, in the last quarter as well as current quarter. However, probability of growth improving over next 6-8 quarters has increased.As the economy recovers, demand for investment and credit will pick up. To meet this demand, RBI has reduced the SLR requirement for the banking system to expand credit to the non-government sector. To our understanding, this action is neutral to the market and unlikely to affect the G-sec yields, as the credit growth is already low at 13.5%, so even if there is some improvement in the credit growth, it will get accommodated by the banking system, as we expect liquidity in the system to be at appropriate levels, supported by the RBI.

We continue to believe that bond yields are likely to remain range-bound with a downward bias, in the medium term. Fiscal consolidation, continued improvement in current account and moderating CPI could provide RBI, the space for monetary easing and lower interest rates. We continue to remain positive on interest rates, and in next 4-6 quarters, there could be about 100 bps decline in bond yields. In light of this, we believe that current levels of about 8.75% on 10-yr bond yields are attractive to invest and we continue to advocate fixed income investors to participate in the medium term and long term duration funds from the ICICI Prudential stable.