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RBI Policy and Fixed Income Strategy – April 2019

Highlights:

  • Monetary Policy Committee (MPC) decided to further reduce repo rate by 25 bps (4:2 majority) to 6%, while keeping stance neutral (5:1 majority). The rate cut follows a 25 bps cut in the last MPC meeting in Feb-19.
  • The MPC did not move to an accommodative stance probably given fear of reversal of food prices, uncertainty on fuel inflation and asymmetric impact of output gap on pricing powers.
  • While the policy rate cut of 25 bps with a neutral stance was widely expected, anticipation of a more dovish policy through either a change in stance to accommodation or a deeper cut, led to the negative reaction in markets.
  • The Reserve Bank of India (RBI) has cut both its growth and inflation forecast as well.
  • The MPC re-iterated its commitment to improve transmission of monetary policy and maintain adequate liquidity in the system. Introduction of the USD/INR swaps and the dispensation on FALLCR through the 2% extra SLR carve out are steps in the same direction.
  • While we do not rule out another rate cut in the year, the move would be based on realized inflation and growth outcomes. The MPC might wait for more certainty on inflation trajectory, fiscal situation and some indication of transmission of the twin rate cuts, before taking a call on rates.
  • Long term bond yields have been sticky owing to decreased expectations of OMO purchases from RBI & heavy borrowing programme for the financial year.
  • RBI had done USD 5 billion swap in March and announced further USD 5 billion swap. The introduction of the forex swap tool for liquidity has had a very benign effect on short end rates. 3 Year AAA has come down by close to 30 bps since announcement of first tranche of swap.

While shorter term bond (1-5 years) yields have come down over past 1 month current yields on corporate bonds still provide high real yields. Hence we continue prefer Short term & corporate bond funds (AAA & AA) with tenure of 2-5 years.