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Below Comment on RBI Monetary Policy by Sandeep Yadav, Head of Fixed Income, DSP Mutual Fund

RBI continued its dovish call on liquidity. Expected.

In fact, RBI’s statement ‘will continue to be proactive in liquidity management’ ensures that policy remains soft rather than hard. For perspective, liquidity is so abundant that overnight rates are much lower than repo.

In fact, RBI showed concerns on CP/CD rates remaining elevated.

So, where is the risk of rate hikes?

RBI increased inflation expectation due to Iran war. But showed concerns for growth. Expected.

BRI put CPI projections at 4.6% (with upside risks) but expressed concerns on growth at 6.9% (with further downside risks) due to fuel supply constraints.

But RBI also added the risk of financial market volatility to growth. That probably was not par for the course.

Moreover, RBI expressed risk of Iran war become systemic when they said that ‘initial supply shock may potentially become a demand shock’.

Thus, the growth fears don’t look transitory. On the other hand,  core inflation projection is not high at 4.4%. In fact, the very mention of core inflation shows that RBI is willing to look through the transitory CPI rises due to agri & fuel shocks.

Final takeaway:

The Iran war will drive RBI’s future trajectory. But it will be a wrong conclusion that long Iran war necessarily means higher rates. It could also mean lower growth, and thus lower rates. We believe it is too early to even talk about rate hikes.

Note: El Nino has found its space in Gov Speech. This should drive the conversations for next few months. However, India has strong buffers in cereals and the El Nino risks, while significant, are much lesser than in the past.

 How to invest?

Remain long. Today yields have fallen 10-15bp across the curve. We maintain our view that money market segments will trend even further lower. The duration will remain at whims of Mr. Trump and Iran war. But the latest ceasefire shows the risks are that yields should gravitate slightly lower due to lower expected (i) lesser inflation, (ii) fiscal expansion, and (iii) global financial markets turmoil.

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