RBI Monetary policy: Key takeaways

By Dhaval Kapadia |  10-02-22 | 

The asset class research of the Morningstar Investment Management team suggests that going ahead, investors will struggle to post significant gains in bonds as interest rates are expected to move upwards. The annual return expectation from bonds would be more normalized as compared to high teen returns delivered in the last couple of years.

From a long-term perspective, we think bonds remain a necessary stabilizer for multi-asset portfolios, and medium-long duration bonds are likely to provide a cushion when equities sell-off as they offer attractive real rates.

Based on our valuation implied return (VIRs) forecasts, the medium to long-term debt segment (5-10 years maturity) looks relatively more attractive than cash and high credit quality short-term debt.

On the corporate bond side, credit spreads have also narrowed lately, compressing the net of expenses yield difference between banking PSU debt funds and credit risk funds. Although the absolute return expectation for credit risk is slightly higher due to better carry. However, one should be mindful of potential downgrades and defaults and their impact on the credit spreads which needs to be monitored carefully.

Key takeaways of the central bank policy

  • RBI’s MPC leaves the repo, reverse repo and MSF & bank rates unchanged at 4%, 3.35% and 4.25% respectively to revive & sustain growth and on expectations of a moderation in inflation in the FY22-23. Some market participants were expecting an increase in the reverse repo rate to begin policy normalisation. This has been pushed ahead with no immediate indication of when normalisation would start. The MPC is probably drawing comfort from expectations of a moderation in inflation over the next fiscal year.
  • This dovish signal drove bond yields lower by 15-20bps with the benchmark 10-year Gsec currently trading at 6.72% (vs 6.93% couple of days ago). This was despite the RBI not announcing any measures to manage the Government’s large borrowing programme for FY22-23 as per the Union Budget.
  • Nominal GDP growth projected at 12.3% for FY22-23 vs government’s assumption of 11.1% as stated in Union budget FY22-23. Real GDP growth projected at 7.5% for FY22-23 by RBI.
  • CPI inflation projected to moderate to 4.5% in FY22-23 on a favourable base effect and moderating food prices. The RBI has mentioned rising crude oil and elevated commodity prices as risks to inflation but believes that global growth may decelerate due to expected tightening of monetary conditions to be undertaken by major central banks in advanced economies. Deceleration in growth is expected to result in a moderation in commodity prices.
  • Overall the RBI seems to be focussing more on domestic growth-inflation dynamics to decide the future course of monetary policy vs taking immediate cues from central banks in advanced economies which have initiated policy normalisation. A comfortable macro situation with rising forex reserves, stable INR and moderate current account deficit (CAD) would be supporting this view.
  • Focus of fixed income markets would now shift to the Government’s large borrowing program for next fiscal, how the RBI will manage it and how it views the G-sec yield curve.
  • Extension of the Term Liquidity Facility of ₹50,000 crores to Emergency Health Services and of the On-tap Liquidity Window for Contact-intensive Sectors, by 3 months up to June 30, 2022.
  • Limits under the Voluntary Retention Route (VRR) route for FPI investments in Indian bonds, enhanced by ₹1 tn to ₹2.5 tn with effect from April 1, 2022.
  • Final guidelines for Credit Default Swaps (CDS) to be issued – CDS instruments aid in managing credit risk and could play a key role in deepening the corporate bond market.
  • Banks permitted to deal in offshore Foreign Currency Settled Rupee Derivatives Market – This would help remove the segmentation between onshore and offshore markets and improve the efficiency of price discovery.
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