The MPC has revised interest rates downwards by 75 basis points so far in the calendar year 2019.
- By Lakshmi Iyer
The MPC unanimously decided to cut benchmark interest rates by 25 basis points in the MPC meeting that ended 6 June 2019. The rate cut was broadly in line with ours and market expectations. The MPC has revised interest rates downwards by 75 basis points so far in the calendar year 2019. The decision was guided by GDP growth which slumped to a 5-year low of 5.8% during Q4 FY19. Moreover, the inflation forecasts continue to be within the MPC’s comfort level. What is interesting is that the MPC has changed its stance to ‘accommodative’ from ‘neutral’ with no dissent from any of the members! It has also noted that the transmission of delivered rate cuts has been satisfactory in bonds and money market instruments.
Growth prospects of the economy have seen a slowdown while the CPI remains within inflation target of 4% (+/-2%) despite the previous two policy rate cuts. The CPI estimates were revised marginally to 3.0-3.1% (vs 2.9-3.0%) in H1 FY20 and 3.4-3.7% (vs 3.5-3.8%) in H2 FY20 with risks broadly balanced. The MPC noted that food prices have risen during the summer months. However, the MPC has projected a downward reversal of perishable prices during the coming months. Crude oil prices have been volatile in the near term and the trajectory remains highly uncertain for the future. GDP projection has been revised downwards to 7.0% for FY20 as compared to 7.2% projected earlier. It seems like the economic fundamentals guided by slowing growth and soft inflation readings warranted continued rate cuts.
On the market front, we did see the bond yields come down a tad, though much of the price rally did happen over the last few weeks. It is pertinent to note that the 10-year G-sec yield has rallied ~50 basis points over the last month mainly due to favourable election outcome, continued OMO purchases, softening in UST yield and falling crude oil prices. Given that too many positives are priced in, it is natural we may see some back up in yields. We would, however, view that as a buying opportunity. The liquidity in the banking system has moved from deficit to the positive territory. This bodes well for bond yields to anchor future expectations as well.
Continued OMO purchases also is a key to sustain lower G-sec bond yields as the supply issue is not completely behind us. Foreign Portfolio Investors (FPIs) continue to buy India bonds. The month of May was the 2nd month in CY 2019, where we have seen positive net flows by FPIs (March was the 1st month). With nominal and real yields still looking attractive, we expect this trend to continue.
Going forward, the government’s fiscal consolidation plan, fiscal deficit target and borrowing plan will be closely watched in the near term. Markets could be punitive if there are any material slippages on the fiscal front. We prefer the 1-3 year segment of the yield curve in high-grade bonds, where spreads continue to be lucrative.
Finally, we are of the view that the rate cut cycle is not over. For private investment cycle to revive, real interest rates are likely to fall even further. Hence it is yet not late to allocate to India fixed income. Key risks to our view are sharp jump in global oil prices, below normal monsoon and higher fiscal deficit projections.
- Lakshmi Iyer is Chief Investment Officer (Debt) & Head Products, Kotak Mahindra Asset Management Company. Views are the author’s own