Bonds rallied on Wednesday even after the Reserve Bank of India’s (RBI) monetary policy committee (MPC) hiked the repo rate by 25 bps to 6.5% with the yield on the benchmark bond down seven basis points (bps) at 7.701%. Treasurers said the rally was the result of the central bank maintaining a neutral stance for the second consecutive meeting now.
Ananth Narayan, professor of finance at SPJIMR, believes there are chances of further rate hikes and the inflation forecast projected at 4.8% for H2FY19 will likely reach 5%. “Further rate hikes are still on the table as indicated by money and bond markets,” Narayan said.
The policy stance remains neutral even after back-to-back rate hikes, perhaps indicating the MPC expectations of a shallow rate hike cycle. “For one, the MPC’s consumer inflation projections are moving further away from the 4% target over time. Second, there is still considerable uncertainty in the medium term over global and local factors and event,” Narayan said.
Manish Wadhawan, MD and head (fixed income), HSBC India, observed that there may be persistent liquidity tightness over the next six months, mainly because of currency leakage. “We will have to see how much open market operations (OMOs) the RBI does to bring the liquidity situation to normal,” Wadhawan said.
Economists pointed out the sheer supply of government bonds – states and centre – especially in the second half of the year, could keep the yields elevated. RBI deputy governor Viral Acharya said the system liquidity has remained in the neutral zone on most days in June and July apart from modulations related to tax outflows and changes in government cash balances.
“The system is otherwise in a small surplus on an average and this is also reflected in the fact that the overnight lending rates and weighted average call rates, which we monitor closely in determining our transcend liquidity management, it has remained on an average 10 bps below the policy rate during the June and July period,” Acharya said. He added that reserve money growth is expected to pick up in the second half of fiscal year 2018.
The repo rate now stands at 6.5%, the reverse repo rate under the liquidity adjustment facility (LAF) stands adjusted to 6.25%, and the marginal standing facility (MSF) rate was fixed at 6.75%. Four out of five members voted in favour of the hike with an aim to achieve the medium-term target for headline inflation of 4% on a durable basis.
The RBI’s projection for gross domestic product (GDP) growth for FY19 was maintained at 7.4%. The MPC stated that GDP growth will range between 7.5% and 7.6% in H1 and 7.3% and 7.4% in H2. Inflation is projected at 4.6% in Q2FY19, 4.8% in H2FY19. Noticeably, for the first time ever the MPC put out its projection for Q1FY20 at 5%.
The MPC said, “The staggered impact of the house rent allowance (HRA) revision by state governments may push headline inflation up. While the statistical impact of HRA revisions will be looked through, there is a need to watch out for any second-round impact on inflation.”