RBI is entering a new era with the first MPC (Monetary Policy Committee) meet scheduled for the 3rd and 4th of October 2016. The outcome of the meet will be released at 2.30pm on the 4th of October. The outcome will be decided by votes, three from government nominees and three from RBI including the governor, with the governor having the casting vote. RBI has now moved to a Fed style of functioning.
The MPC has a target, which is the CPI inflation that is to be maintained at 4% with +/- 2% leeway. Inflation outside this range requires explanation. Inflation printed at 5.05% for August 2016 and RBI forecast for inflation is 5% as of March 2017.
The MPC has many factors to ponder while taking its first policy decision. Impending Fed rate hike, worries over Deutsche Bank and its potential effect on financial markets if the bank fails to strike a deal with the US Justice Department on the USD 14 billion fine imposed on the bank, the ongoing Indo-Pak tensions and also potential repercussions on an adverse US presidential outcome. These events could lead to high risk aversion globally leading to capital outflows that would impact the currency, bond and equity markets.
The latest economic data does not present a bright picture of the economy with IIP growth for July negative and export growth for August negative. Bank credit growth is below double digit levels. Demand drivers are still showing weakness though there are signs of increased confidence in sectors such as auto and cement and retail (ecommerce). Big e retailers sales are expected to see high traction in the beginning of October.
India’ macros are looking good. Inflation is staying down, CAD for the first quarter of 2016-17 was just USD 0.3 billion and External Debt for the first quarter was lower than that of last year. Implementation of GST, spectrum sales and black money disclosure will add to government coffers, making fiscal deficit easily manageable.
Given that macros are strong and the economy is still to show strong recovery, case for a cut in the Repo Rate is there for the MPC. However, other internal and external issues could force the MPC to postpone rate decision to its next meeting in December.
RBI will still maintain its accommodative stance, rate cuts or no rate cuts and will provide liquidity to the system through OMO’s if required. There will be more clarity on FCNR B outflows and RBI’s swap operations post this meet.
Government bond yields closed mixed last week on the back of Indo-Pak tensions. The new benchmark ten year bond, the 6.97% 2026 bond saw yields close up by 2bps week on week to close at levels of 6.82%. The old benchmark ten year bond, the 7.59% 2026 bond saw yields close flat week on week to close at 6.97% levels while the 7.88% 2030 bond saw yields falling by 3bps to close at 7.05% levels. The 8.13% 2045 bond saw yields rising by 1bps to close at 7.18% levels. Bond yields will take direction post RBI policy on 4th October.
Credit spreads closed mixed last week. Three year benchmark AAA credit spreads rose by 3bps to close at 57bps level while five year spreads closed flat at 42bps levels and ten year spreads fell by 7bps to close at levels of 54bps. Credit spreads will stay ranged till RBI policy on 4th October.
OIS market saw one year OIS yields close up by 2bps and five year OIS yields close up by 4bps week on week. One year OIS yield closed at 6.47% while five year OIS yield closed at 6.37%. OIS yields will stay ranged till the RBI policy on 4th October.
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) was in deficit of Rs 465 billion as of 23rd September. The surplus was Rs 67 billion in the week previous to last. Government surplus was Rs 281 billion last week as compared to Rs 262 billion in the week previous to last. Liquidity eased on maturity of RBI forward purchase contracts and will ease further on government spending.