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Rising tussle between markets and RBI

* RBI MPC stayed on hold and emphasized it remains committed to keeping the policy accommodative for the foreseeable future and maintaining ample liquidity. As per RBI, the growth outlook looks buoyant and inflation risks look balanced. But the RBI maintained that growth still needs to gather firm traction and that continued policy support is crucial for durable growth revival.

* Markets, however, were not too enthused even as the RBI tried to assuage them on managing liquidity and the heavy G-sec borrowing schedule ahead. We reckon a more vocal and defined OMO calendar could have led to much lower sovereign risk premia, which has been reeling under pressure. The markets-RBI face-off could keep yields elevated in the near term. However, any premature tightening of the financial condition is unwanted at this juncture.

* We expect the RBI to get more accountable and action oriented as we move into FY22. We think the liquidity management will be calibrated well to ensure that the accommodative stance is maintained, money market skewness is tackled and pressure on the longer end of the curve is managed well. Tools like MSS bonds and/or SDF introduction will likely be explored in FY22. On conventional rates, we think the fear of policy normalization to resume in FY22 is unfounded. We see the RBI on status quo in FY22 and believe inflation may surprise RBI a tad to the downside.

RBI roots for continued accommodative stance amid favorable growth-inflation mix…

The RBI MPC expectedly kept the policy rates unchanged with a unanimous vote, but continued stressing on accommodation abound both on policy rates and liquidity front amid lower inflation and stronger growth. The growth forecasts were raised. Near-term inflation forecast was revised down, but raised for H1FY22. The RBI sees FY22 growth at 10.5% (in the range of 26.2-8.3% in H1FY22 vs. 21.9-6.5% earlier and 6% in Q3FY22). The governor noted improving capacity utilization and reviving consumer confidence as signs of significant growth traction. Headline CPI inflation is now seen at 5.2% for Q4FY21 (5.8% earlier), 5.2-5% for H1FY22 (5.2-4.6% earlier) and 4.3% in Q3FY22. The MPC stated that risks to inflation forecast look balanced, with strong Kharif arrivals and Rabi output to be offset by possible cost push pressures in non-food and non-perishable goods. While we are fairly close to the RBI on growth, we think inflation could surprise the RBI to the downside in H1FY22.

…and tries to break the negative loop of liquidity (mis)communication and sovereign premia

The governor stressed that markets misconceived RBI’s liquidity stance post variable reverse repo announcement and that the liquidity stance is unlikely to diverge from the accommodative policy stance. The governor ensured completion of the elevated market borrowing programs in a nondisruptive manner, subtly hinting that they would be the heavy-duty balancing factor in Gsec demand-supply ahead. The phased normalization of CRR, which now rolls over to FY22 (to be done in March and May by 50bps each), is liquidity-positive in the near term and for shorter-tenor rates. It could also imply lesser chances of higher OMOs in the Q4FY21. Dispensation of enhanced HTM of 22% to March 31, 2023 is market neutral. Allowing NBFCs to access on-tap TLTROs will improve liquidity at the margin for non-AAA NBFCs whose market access was not restored to pre-Covid levels. Other regulatory measures like easing of CRR norms for new MSME loans, microfinance norms and retail participation in gilt market are welcome reforms.

…but markets may choose to wait and watch

We have been arguing that the (mis)communication loop between the RBI and markets needs to be broken on the liquidity management front (see “That Taper Tantrum like feeling…”, Jan 19,2021), and that the unintended financial tightening amid nascent growth recovery are neither optimal nor desirable at the current juncture (see, “A call for complementarity”, Feb 4, 2021). While the RBI stressed on smooth liquidity management and orderly Gsec borrowings, we would have liked a more vocal and defined OMO calendar that could have led to much lower sovereign risk premia, which has been reeling under pressure amid elevated borrowings ahead. The moves like extended enhanced HTM and retail participation in Gsec market will only reduce Gsec premia only at the margin.

Face-off between RBI and markets: keeping an eye on sovereign risk premia

Going ahead, even as we think inflation may surprise marginally on the downside, we do not see scope for conventional rate cuts and think the fear of policy normalization to resume in FY22 is unfounded. However, the tussle between the markets and the RBI in the near term could keep yields under pressure in the near-term. We, however, expect the RBI to get more accountable and action oriented as we move into FY22. We reckon that a lower welfare cost of public debt may be needed when public funds are used for investments addressing growing economic externalities. We believe that the liquidity management will be calibrated well to ensure that the accommodative stance is maintained, money market skewness is tackled and pressure on longer end of the curve is managed well. The RBI will continue to strive fixing the artificially-skewed yield curve and maintain its preference for curve flattening. We watch out for possible tools like MSS bonds and/or SDF introduction during the year.

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