A vendor sorts tomatoes as he waits for customers at a vegetable market in Mumbai, India. Reuters
Despite recent strength in India’s factory sector, the Monetary Policy Committee said economic activity in India “remains subdued and the few indicators that have moved up recently are yet to gain traction in a more broad-based manner.” The central bank lowered its growth forecast for the first half of the upcoming fiscal year to 5.5 per cent-6 per cent, from its December projection of 5.9 per cent-6.3 per cent.
RBI’s Monetary Policy Committee (MPC) forecast inflation in the ongoing fourth quarter of fiscal 2020 to hit 6.5 per cent, and then move lower in a 5.4 per cent-5 per cent range in the first half of the upcoming fiscal year, which is still up from its prior projection of 4 per cent-3.8 per cent for that period. The RBI targets medium term inflation at 4 per cent levels.
Annual retail inflation surged to more than a five-year high at 7.35 per cent in December, mainly driven by food prices.
That comes against slowing growth in Asia’s third-largest economy. Annual gross domestic product (GDP) growth most likely slipped to 4.3 per cent in the last three months of 2019, according to a forecast from Nomura. It had dropped to 4.5 per cent the previous quarter, its slowest in more than six years.
The RBI cut its policy rate by 135 basis points over five straight meetings last year, before surprising markets in December by standing pat due to the concerns over inflation.
“RBI’s Monetary Policy Committee (MPC) recognises that there is policy space available for future action. The path of inflation is, however, elevated and on a rising trajectory,” the MPC said, while upwardly revising its near-term inflation projections.
Meanwhile inflation is expected to ease off to 7 per cent and gradually trend towards the comfort zone and long-term Repo Operations announced by the Reserve Bank of India (RBI) will push the short-term rates down and eventually lower the longer-end of the curve too, Kotak Mutual Fund said.
“We believe we have seen peak of inflation in January 2020 with head line CPI at 7.35 per cent. However, based on current prices we expect the same to ease off to 7 per cent and gradually trend towards the comfort zone”, the Fund said.
Long-term Repo Operations announced by the RBI will push the short-term rates down and eventually lower the longer-end of the curve too. There will be an immediate transmission in the sovereign assets, which will lead to a chase in the corporate bonds lowering the corporate bond yields too.
The comfort level of inflation is four per cent (+,-) as per the RBI mandate.
The government admitted to a fiscal slippage and pegged the Fiscal Deficit at 3.8 per cent for FY20. But it stuck to the glide path and the next year has been pegged the Fiscal deficit at 3.5 per cent. To its credit, the government did not increase the market borrowing for the current year and next year borrowing programme was also as per market expectations.
“We will have to see how soon India will be a part of Global Bond Index for further direction”, it said.
The geo-political risk has moved from the US-Iran to China with respect to Wuhan- coronavirus issue. As of now the risk of a global slowdown is increasing, i.e, positive for interest rates.
Global risk-off led to bond yields falling sharply in the US Treasuries. The yields of other developed economies also continue to remain low. This may, sooner than later, lead to chase for Indian sovereign assets which are still offering high real rates, Kotak said.
India is probably preparing for inclusion in Global EM bond indices. The Union Budget has paved the way for the same and hopefully this may see the light of the day by end of the year. This will be a huge positive for long bonds. Liquidity is in huge surplus mode but market is yet to price this new phase. Positive liquidity is a more important tool than repo rate cut.
“We maintain that due to ‘operation twist’ the rate cut cycle has been elongated by at least six month. We expect at least 25-50 bps cut in the policy rates in CY20. Market may still be in denial mode which gives a window of opportunity for the long term investors.
“In a nut shell, key driver for returns will be corporate spread-compression or flattening of the yield curve. It will start with the AAA/PSU followed by the NBFC/HFC like Bajaj/HDFC, and then, it may percolate to lower grade NBFC and other corporate bonds,” the report pointed.
“We believe that the investment opportunity in short duration bond funds, banking and PSU funds, credit funds and dynamically managed duration funds is still present and becoming more attractive. Investors may look to invest in the funds depending on the scale of risk appetite and the investment horizon”, it said.