RBI has finally decided to do an open market operation (OMO) purchase to cool yields. We continue to expect policy makers to further try to comfort sentiment in the G-sec market. After all, the 125 bp yield spike since the last RBI rate cut in August 2017 is pushing up lending rates to delay recovery. The May 4 announcement strengthens our call that RBI OMO will push the government securities (G-Sec) market into excess demand in FY19, a la 2016, with rising oil prices and weaker portfolio flows limiting RBI’s foreign exchange intervention. Our liquidity model estimates that RBI will need to inject $37 billion of reserve money/ durable liquidity in FY19.
Our balance of payments (BoP) projections halve RBI foreign exchange (FX) intervention to $15 billion (at our $64/bbl forecast for crude prices) from FY18. This implies that RBI will have to make OMO buys of $22 billion (including ~$11 billion of the budgeted government buyback). This, in turn, will push the G-sec market into excess demand. On balance, we retain our forecast of a August 1 RBI rate-cut as we are now tracking April CPI inflation at 4.2%, a shade below March’s 4.3%.
We continue to believe macro risks are overdone in the G-sec market:
- Our liquidity model estimates that RBI will need to inject reserve money/durable liquidity of about $37 billion in FY19 to sustain 6% old series GDP growth. It supplied our $30 billion forecast last year.
- Our BoP forecasts see FX intervention almost halving to $15 billion in FY19 on higher oil prices and lower foreign flows. This assumes our $64/ bbl oil price forecast. $10/bbl impacts the current account deficit by $9 billion. If oil persists at the current $75/bbl, RBI may have to sell, say, $5 billion of FX.
- RBI will have to supply the balance liquidity of $22 billion through OMO purchases and government buybacks (~$11 billion budgeted).
- This, in turn, should push the G-sec market into excess demand.
Food inflation continues to come off even in May. With inflation peaking off, RBI MPC should overlook the jump in June inflation to 5% levels on base effects. With our estimate of FY19 CPI averaging at 4.3% (ex base effects), we think that the RBI MPC’s inflation risks are overdone:
- Budget FY19’s MSP hikes: Limited inflation impact as the revised MSPs still below market prices in most crops.
- HRA revision by states: Unlikely to be significant, just as the Centre’s wasn’t.
- Fiscal slippage: We ourselves see 20bp in FY19 (3.5% of GDP). This can hardly be inflationary when capacity utilisation is languishing at 74%.
- Monsoons: The Met has forecast a good monsoon, at 97% of normal.
- Volatile crude oil prices: Our oil strategists see Brent at $62/bbl by December. Delhi has reportedly asked OMCs to absorb `1/L hike instead of raising prices for the consumers in a pre-election year.
Co-authored with Aastha Gudwani, India economist, BofAML Exerpted from BofAML’s India Economic Watch report, May 7
The author is Co-head and economist, India Research Bank of America Merrill Lynch
