Published on 4/02/2020 3:59:13 PM | Source: Quantum Advisor​​​​​​s Pvt Ltd

Pre RBI Policy comment by Arvind Chari

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Below is the Views On Pre RBI Policy comment By Arvind Chari Head - Fixed Income, Quantum Advisor

The next trigger for the bond market will come from the monetary policy review, due on 6th February.

With the government seemingly delivering the budget (exactly) as per the bond market’s expectations;

1) Increased the fiscal deficit for FY 20 to the market consensus level of 3.8% of GDP, but without any additional market borrowings;

2) Limiting the fiscal expansion in FY 21 at 3.5% of GDP as per market expectations; and

3) Dangling the carrot of foreign sources of demand for government bonds with the announcement of specific bonds being open for 100% FPI ownership, paving   way for inclusion in global bond indices.

The bond market has reacted positively with long term bond yields falling by more than 10 bps (0.1%) and the 10 year government bond yield back at 6.5%; the level at which it was prior to the December monetary policy meeting.

In December, the MPC (Monetary Policy Committee) of the Reserve Bank of India (RBI) spooked the markets by pausing its rate cutting cycle. 10 year government Bond yields spiked up to 6.8%, fearing which the RBI announced one of its boldest moves ever, ‘Operation Twist – a move where they buy long term government bonds and sell short term government bonds – to manage the yield curve. The Bond market immediately reversed its bearish trend and the 10 year bond yield has since traded broadly between 6.45%-6.7%.

We had opined then that the Operation Twist is an admission of two things:  A) the RBI does not see a deep rate cutting cycle from the current Repo rate level of 5.15% and any rate cut will be delayed ; and  2) the government is certain to breach the fiscal deficit and hence the bond market will require support to manage the spike in bond yields.

So, the most important cue from this MPC meeting would be on what the RBI Governor mentions as the rationale for undertaking ‘Operation Twist’ (OT).

The thing with OT, unlike OMOs, is there is no certainty on the amount and the timeline. There is (technically) no limit to how much OT they can do. If they run out of bonds to sell, they can issue MSS bonds and continue with OT.

Then it comes down to the objective. It if was for managing fiscal and capping bond yields, then the OT will be tactical and opportunistic. As and when they see weekly auctions suffering to clear, the may announce OT’’

If the objective was to manage the yield curve, to get the term spreads down, then it can remain for as long as the objective is to be met. For eg: to enable transmission, they would like the 10-year-repo spread to be at 100bps, today it’s 135; markets can then assume OT to continue as long as the objective is met.

The RBI thus needs to very careful in commenting on the objective of Operation Twist and to be honest, their communication on monetary policy objectives has been wanting for a few years now.

On rates, we expect the MPC to remain on hold, but indicate that monetary policy space exists as food prices ease going forward. But on balance, they will increasingly be data dependent and the focus will remain on managing liquidity and aiding transmission.


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