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RBI Policy and Fixed Income Outlook - December 2018

The Monetary Policy committee announced its Fifth Bi-monthly Monetary Policy for the financial year 2018-19.

 

Key Points:

  • In line with market expectations, India’s monetary policy committee (MPC) voted unanimously to keep policy rates on hold and voted 5-1 to maintain its monetary policy stance of “calibrated tightening”.
  • More significantly, the 2H FY19 CPI forecast has been revised down to 2.7 – 3.2% (3.8 – 4.5% earlier) &1H FY20 to 3.8-4.2% (4.8% for 1Q earlier) – almost 100bps downward shift on back of substantially lower food inflation and falling oil prices. Growth forecasts have been kept largely unchanged.
  • Having announced INR 1.76 tn of OMO purchases till December, RBI officials have given comfort on continuing durable liquidity provision through OMOs in 4Q FY19.
  • RBI policy is clearly dovish given the sharp downward revision in CPI and allusion to continued support through bond purchases.
  • Governor explicitly mentioned that in the event of upside risks to inflation not materializing, leading to durability of existing inflation prints, the committee would take appropriate policy action. This would imply that a change in stance could not be ruled out, if risks to inflation and external sector volatility are muted.
  • Yields are lower across bonds and OIS even as RBI held policy rate unchanged and retained the ‘calibrated tightening’ stance. 10 Year bonds closed down by close to 14 bps at 7.44 levels.
  • In US, difference between two and 10-year Treasury yields narrowed to a new cycle low of 11 basis points (1/100 of a percent). Infact, yields on 2 year is higher than 5 year yield. When longer tenure yields may fall below the shorter tenure, called as yield curve inversion, which is normally seen to be a sign of impending recession.
  • In Indian context, benign inflation prints, sharp fall in oil prices, possibility of a change in monetary policy stance, continued OMO purchases, favourable demand-supply situation and the recent fall in global yields especially the sharp US curve flattening points towards lower bond yields.
  • 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 Short term & corporate bond funds (AAA and AA) with tenure of 2-6 years