Debt and forex market traders reacted strongly with surprise as the seemingly dovish tone of the central bank at the time of announcing the April monetary policy turned out to be distinctly hawkish after minutes of the Reserve Bank of India’s monetary policy committee (MPC) meeting were released late on Thursday. It was no surprise, then, that bonds sold off on Friday when trading opened. The benchmark yield closed at over a one-month high of 7.72% (up from 7.63% on Thursday) after having surged to as high as 7.795% on an intra-day basis. Trading hours were extended by over an hour on Friday as auction results were late, a bond dealer said.
The cut-off yield on the benchmark bonds during the auction was 7.77% — near the high of the day. The rupee too closed at a one-year low of 66.10 against the dollar, on the seeming shift in monetary policy stance along with factors like a stronger dollar (against a basket of currencies) and firm crude prices.
Suyash Choudhary, head, fixed income, at IDFC AMC agrees that the effective signalling in the Reserve Bank of India MPC minutes and the April policy document are somewhat divergent. “Despite the flagging of many upside risks to inflation in the April monetary policy, the market took the signal as dovish, given that RBI brought down their forecast for CPI (Consumer Price Index) over FY19.
Now that the MPC minutes clearly state a possible change of stance, a rate hike looks likely by August or October. Moreover, it is also worth noting that crude has been trading higher than the levels when the MPC minutes might have been written,” he said. Manish Wadhawan, managing director and head, fixed income, global markets, at HSBC India, points out that the details of the MPC minutes reflect the committee members’ highlighting the risks to higher inflation because of fiscal slippage due to forthcoming elections in states and the Centre and potential increase of the minimum support price.
“The minutes also indicated that the output gap could be closing and oil price spike also could be a risk factor. Furthermore, deputy governor Viral Acharya pointed out that he is likely to vote for a beginning of ‘withdrawal of accommodation’ in the next meeting in June. All these factors indicate a possible rate hike in June, which is taking a toll on the bond yields and rupee. Going forward, the market will be keenly watching out for the tone of the central bank and would like to understand the possible impact of the RBI’s change of stance on liquidity measures and policy rates,” he said.
What’s noteworthy is that the benchmark yield has surged more than 50 basis points in the past two weeks, having wiped out the gains made on the back of a string of positive news like the government’s announcement of reduction in first-half market borrowing, reduction in the duration of the paper, banks getting permission to spread mark-to-market provisioning across four quarters, dovish tone in the April policy and a softer inflation print for March.
At the MPC meet, Acharya stated that he is likely to shift decisively to vote for a beginning of “withdrawal of accommodation” in the next MPC meeting in June. “Reinforcement of inflation-targeting credibility that such a shift would signal is crucial in my view for prudent macroeconomic management, on both the domestic and external sector fronts,” he said. Acharya supported his change of stance indicating that uncertainty on the possibilities of softening of oil price outlook due to US shale gas response and growth recovery in the economy still being nascent have receded.
In two weeks, Brent crude has surged by more than $6 to $73.17 a barrel as on Friday evening — levels that are close to three-and-a-half-year highs. The deputy governor also indicated that output gap is closing and the recent softening of vegetable prices is a function of seasonality rather than durable supply management.
In the April monetary policy, the central bank had trimmed its projections for the CPI inflation for the first half of FY19 to 4.7-5.1% from 5.1-5.6% as stated in the February monetary policy. Even for the second half of the fiscal, the RBI dropped its estimates to 4.4% from 4.5-4.6%. The MPC minutes indicate that although the estimates have been trimmed, members of the committee are still concerned over possibilities of fiscal slippages in the election year.