Extended pause likely for the repo rate

10-year G-sec yield likely to trade in7-7.3 per cent range in Q1 of this fiscal

In line with our expectations, the Monetary Policy Committee (MPC) left the repo rate unchanged at 6 per cent in the First Bi-Monthly Policy Statement for 2018-19.

It retained the neutral stance on monetary policy and reiterated the commitment towards achieving the medium-term inflation target of 4 per cent.

Following the sharp dip in the CPI inflation from 5.1 per cent in January 2018 to 4.4 per cent in February 2018, the MPC has revised downwards the inflation trajectory that it foresees, particularly for the first half of this fiscal.

However, volatility in crude-oil prices, pass through of higher input costs to final prices and improvement in aggregate demand could pose some upside risks.

Other sources of uncertainty regarding the inflation trajectory include the final contours of the revised formula for minimum support prices (MSPs) announced in the Budget, monsoon dynamics, the staggered impact of HRA revisions by the State governments and fiscal slippages.

A normal onset and magnitude, and appropriate temporal and spatial distribution of rainfall in the upcoming monsoon would be important for the rural sector.

Recovery in growth

The MPC expects GDP growth to improve substantially from 6.6 per cent in FY2018 to 7.4 per cent in FY2019, benefiting from an emerging revival in investment activity and improving global demand.

The Committee highlighted that a recovery in growth and closing of the output gap is under way, as reflected in higher credit offtake and fund-raising from the primary capital market.

Moreover, it flagged the risk that rising trade protectionism and financial market volatility could disrupt the global economic recovery.

In this unsettling global context, the MPC highlighted the importance of ensuring that domestic macroeconomic fundamentals are strengthened.

The latter, in conjunction with the lowering of the CPI inflation projections for FY2019, suggests an extended pause for the policy rate.

There is a low likelihood of a change in the repo rate or stance of monetary policy until there is clarity on the impact of the MSPs, monsoon and fiscal risks on the inflation trajectory, which are unlikely to emerge in the next few months.

Cooling of G-sec yields

As a result, yields of Government of India securities (G-sec) cooled significantly after the policy announcement.

The 10-year G-sec yield declined by around 15 bps relative to the previous day’s closing level, even though the status quo in the policy was as per market expectations.

The recent announcement of the Government of India’s market borrowing calendar for the first half of this fiscal, and the notification by the Reserve Bank of India granting banks the option to spread the provisioning for their mark-to-market (MTM) losses on investments held in the available for sale (AFS) and held for trading (HFT) categories in the third and fourth quarters of 2017-18 had already contributed to an easing of G-sec yields, from the high of 7.78 per cent seen in March 2018.

While the subsequent announcement of the hike in FPIs’ investment limit in G-sec and corporate bonds is somewhat smaller than market expectations, it would temporarily dampen bond yields in the immediate term.

Subsequently, the appetite of the FPIs for investing in Indian debt over the course of the year remains to be seen, given the expectation of continued monetary tightening by some global central banks.

The 10-year G-sec yield is likely to trade in 7-7.3 per cent range in the first quarter of fiscal 2019.

The cooling of G-sec yields is expected to transmit to corporate bonds as well.

Lower yields and volatility in Q1 FY2019 may reinvigorate the corporate bond market, after tepid issuance in fiscal 2018, providing a boost to the investment recovery.

The MTM losses for the banks during the third and fourth quarters of 2017-18 are estimated by ICRA at ₹15,500 crore and ₹3,200 crore, respectively, which now can be amortised over four quarters.

This is likely to provide a provisioning relief of ₹10,100 crore for the banks during fiscal 2018.

Moreover, the RBI’s decision to defer implementation of Ind AS by a year for banks has provided much relief to the banking system, whose health is crucial to support lending growth and investment revival in the economy.

The writer is Managing Director and Group CEO, ICRA

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