The MPC Policy today was less hawkish than the market expectations though the policy repo rate hike of 50bps was in line with market expectations. The hike in the policy repo rate was not unanimous with Dr. Asima Goyal voting for a 35 bps hike. The MPC retained its stance as “to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth “ with Prof. J R Varma voting against this stance similar to the last policy meeting. The MPC marginally lowered its GDP growth forecast for FY23 to 7.00% from 7.20% earlier and retained its inflation forecast for FY23 at 6.70%, assuming the price of crude at USD100.
Since the last MPC meeting in August, inflation in the developed economies has remained elevated and central banks across the world have continued to hike rates aggressively with emerging market currencies coming under pressure due to strengthening USD. Bond yields across developed markets have gone up by around 70-100 bps over the last couple of months, commodity prices have come down from their peak levels since June which can have a soothing impact on inflation.
The rise in global bond yields is an important factor impacting the MPC’s decision on policy rates, apart from domestic inflation. The sticky and elevated inflation across the developed economies will mean that US Fed and ECB will continue to hike rates and India, as an emerging market, will need to keep interest rate differentials so as not to compromise on financial stability aspects especially as India is running the twin deficits of Current Account and Fiscal Deficit. Thus the policy rates / yields in the developed market space will play an important part in the outlook for domestic interest rates.
Our View:
Bond markets were expecting a 50 bps rate hike and in that sense there was no surprise.
In the run up to the policy, over the last one month, bond yields had rallied on expectations of Indian government securities being included in the JP Morgan emerging market Bond Index and had bucked the trend of rising global bond yields.
The yield curve has flattened over the last one month as market expectation of the terminal repo rate went up along with tightness in liquidity. The wedge between credit growth (16%) and deposit growth (9.5%) has led to pressure on money market rates and we believe that this will continue over the course of rest of this year. We also expect the banking system liquidity to continue to reduce and turn marginally negative by Feb-March 2023.
We expect the 10yr benchmark Gsec yield to range between 7.25% to 7.75% over the next couple of months and expect some steepness coming back in the curve given the massive flatness we have seen over the last couple of months.
Currently the swaps market is pricing in a terminal repo rate of 7.00% but our view is that the terminal repo rate can be lower than market expectations at around 6.50% – 6.75%. The rate action of central banks in developed economies will have a bearing on the course of rate hikes by RBI and the terminal repo rate.
We would recommend that investors increase their Investments in short duration products while selectively looking at dynamic bond funds as per their risk appetite.
Puneet Pal is Head-Fixed Income, PGIM India Mutual Fund
