The change in sentiment indeed has been a dramatic one. This is even more pertinent given the backdrop of the liquidity crises that engulfed bond markets since the end of September.
On the basis of an assessment of the current and evolving macroeconomic situation at its meeting today, the Monetary Policy Committee (MPC) decided to keep the policy Repo Rate under the liquidity adjustment facility (LAF) unchanged at 6.5%. The RBI also maintained their monetary policy stance of calibrated tightening.
Further, in order to align the SLR (Statutory Liquidity Requirement) with the LCR (Liquidity Coverage Ratio) requirement, it was proposed to reduce the SLR by 25 basis points every calendar quarter until the SLR reaches 18% of NDTL (Net Demand & Time Liabilities). The first reduction of 25 basis points will take effect in the quarter commencing January 2019.
This was indeed a wonderful Xmas gift to the bond markets, which otherwise had been parched of liquidity, and hence lacklustre! The CPI inflation targets were lowered quite meaningfully to 2.70-3.20% in H2 FY 2019 and 3.8-4.2% in H1 FY 2020. That was certainly good news to the markets which saw a 10 basis point rally (0.10%) from pre-policy decision to close of market hours. The 10-year government bond yield closed at 7.44%. This is over 60 bps (0.60%) lower from the previous MPC decision on Oct 5th.
The change in sentiment indeed has been a dramatic one. This is even more pertinent given the backdrop of the liquidity crises that engulfed bond markets since the end of September. Not just government bonds, the negative sentiment was more pronounced in corporate bonds. We saw a huge widening in spreads across rating categories and across maturities. The fallout of IL&Fs episode rapidly morphed itself into potential trouble across NBFC /HFC segment. The good news indeed was an infusion of liquidity in the banking system via Open Market Operations (OMO purchases) which did ease the pain in the banking system.
Fortunately, the ones who called it doomsday for bond markets may have to wait it out for a bit more.
The MPC has retained GDP growth projections 7.4% while reducing the inflation targets. This bodes well from an economic standpoint. What is also adding to the positive sentiment is the fall in crude oil prices. We have seen over 25% fall in crude oil prices since last policy meeting on Oct 5th.
US Treasury yields also are edging lower, with UST 10 year at ~2.92%. The aggression with which the US was likely to hike rates in 2019, seems to be receding. This bodes well for Emerging market currencies, including INR. After a weak inning, we saw ~5% appreciation in INR in the month of November 2018. Foreign Portfolio Investors (FPIs) too returned to bond markets, and were net buyers in November to the tune of ~INR 6800 crore, the second highest monthly positive net sales in CY 2018 (highest was in Jan 18). For CY 2018 to date however the net sales continue to be negative at INR 54,000 crore.
With some cobwebs with respect to the policy out of the way, there could be some participation from foreigners. India still offers one of the highest real rates in the world, which cannot be ignored.
What next from here?
The status quo was in line with expectation and falling crude oil prices has certainly aided this decision. However, given that sustaining low oil prices is key, we believe that policy rates seem to be on a long pause for now. CPI also would a key variable for markets to track given the sharp reduction in RBIs target. Commitment to maintain liquidity augurs well both for long as also the short end of the curve. It seems likely that we get to see OMOs for Jan- March quarter as well, which is great news for anchoring long bond yields. Conducting long-term repos is likely to help the short end of the curve as well.
We have seen a good widening of spreads between government bonds and corporate bonds. The corporate bond yields have not eased in the same quantum as government bond yields. Hence we prefer corporate bonds across maturity and rating profile. Fiscal deficit and politics would continue to be key risk factors to watch out for, hence any sharp slide in yields from these levels may not sustain.
In conclusion, from an investors’ standpoint excessive fear kind of scenarios are where one could realise better value for the buck. We witnessed something similar in bond markets a couple of months back. Important is to stay the course… Most people want to avoid pain, and discipline is usually painful – John C Maxwell.
Lakshmi Iyer, Chief Investment Officer (Debt) & Head Products, Kotak Mahindra Asset Management Company