Our team is happy to share the financial insights from the Indian market as on May 2022.
In an out of turn meeting today, the Monetary Policy Committee (MPC) unanimously voted in favour of
hiking the policy repo rate by 40 bps to 4.4%. It also decided to retain the accommodative stance with
focus “on withdrawal of accommodation to ensure that inflation remains within the target going
forward, while supporting growth”. Consequently, RBI also raised the SDF and MSF rate by similar
quantum to 4.15% and 4.65% respectively. Further, it also raised cash reserve ratio (CRR) by 50 bps to
4.5%, thus withdrawing liquidity to the tune of INR 87,000 crores.
Impact on Economic Growth: RBI noted that the domestic economic activity has stabilised and becoming broad based as the restrictions are eased and the number of daily Covid-19 cases remains low. Again, robust
imports corroborate the improvement in domestic demand. Further, improvement of activity in contact
intensive services is likely to boost private consumption. Overall, RBI expects that the domestic activity is
progressing on anticipated lines. RBI expects the momentum of improvement in economic activity to
sustain on the back of prospects of normal south west monsoon, pick up in discretionary spend, robust
exports, early signs of revival in private capex, etc. The outlook on growth is subject to downside risks
emanating from global dynamics. These includes geopolitical risks sustaining for longer, tighter financial
conditions, elevated commodity prices, continued supply chain disruption, etc.
Taming Inflation: RBI noted the surge in inflation to 7% in March 2022 driven by broad based rise in food
prices along with higher fuel and input prices feeding into the core inflation. RBI expects the inflationary
pressure to intensify in April 2022 and risk of inflation sustaining at elevated levels for longer. RBI does
not foresee the inflation pressure to subside soon as the global spill overs of high food prices is likely to
impact domestic food prices. The key food items like wheat, meat, edible oil, etc. have inched up higher
due to global shortage and rise in price of key inputs. Further, elevated food and crude oil prices feeding
into prices of other items also poses an upside risk to RBI’s FY23 forecast of April 2022. RBI also
highlighted if the inflation sustains for too long at elevated levels, then there is a collateral risk of
inflation expectations getting de-anchored.
Conclusion and Outlook
While the action on policy rates was largely expected in the scheduled June 2022 MPC meeting, the
urgency of policy action especially on the eve of US FOMC meeting along with hike in CRR stumped the
market participants. In its statement, RBI governor also highlighted that it is only part reversal of the
total repo rate cut of 115 bps which MPC did, post the outbreak of pandemic. The Gsec yields surged by
~25 to 45 bps across the curve with yields at the shorter end rising at a faster pace. RBI appears
increasingly concerned on inflationary pressure intensifying but is relatively comfortable with the
growth trajectory.
Going forward, the volatility in the fixed income market is likely to remain at heightened levels in the
near term as the market adapts to the surprising shift and urgency in RBI’s policy. This is likely to lift
yields higher. In addition, elevated commodity and energy prices, large Government borrowing program,
resilient CPI and WPI, high SLR holding of banks, accelerated tightening by major global central banks
etc. are also likely to put further upward pressure on yields. The chances of lower fiscal deficit appear
dim too as the Government outgo on food and fertilizers subsidy might exceed the gain expected in
revenues due to higher tax collections.
Thus, in the near term, most factors appear stacked up against yields. However, these factors have been
prevailing for some time now and the impact has been priced in, to a certain extent, in the current yield
levels considering 10Y yields have increased by over 90 bps in the current calendar year (including
today’s move). Further, hike in CRR and expected widening of CAD and consequently negative Balance
of payment in FY23 is likely to lower aggregate system liquidity over time and thus could open up space
for conducting OMO purchases by RBI in the second half of the year.
On an overall basis, in our view, yields are likely to trade with an upward bias in the near term. Further,
policy normalization is also likely to put upward pressure on yields, especially at the short end. In view of
the heightened near-term volatility and expectations of continued flattening in the yield curve, we
recommend investments into short duration debt funds.
Due to the decision of hiking repo rate, sensex saw a minor upward trend and it closed at 55702.23 on 5.5.2022 (5th May 2022)