In the RBI monetary policy announcement, the Repo rate has been left unchanged at 6.50%. In the final analysis, both considerations of growth and the attentiveness to the risks to inflation, have got equal importance. RBI believes that growth still remains robust, and inflation is within the target limits and manageable. However, the risks to higher prices emanating from potential factors like geopolitical risks, higher oil prices in international markets, impact of any adverse weather conditions etc. cannot be ruled out. Therefore, the RBI has moved on to a clear neutral mode as far as the policy stance is concerned.
The policy announcement by the RBI Governor reads like this: “The prevailing and expected inflation-growth balance have created congenial conditions for a change in monetary policy stance to neutral”. He further stated that “there is greater confidence in navigating the last mile of disinflation”. But there are “significant risks to inflation from adverse weather events, accentuating geopolitical conflicts and the very recent increase in certain commodity prices continue to stare at us. The adverse impact of these risks cannot be underestimated”.
The market would have been a bit happy with at least a small token cut of 0.25%, but the line of argument for neutral stance is quite convincing and valid, and that makes the policy a good one for the markets.
On inflation, the RBI has indicated that the trajectory of headline inflation is projected to moderate sequentially especially in Q4 24 mainly due to better crops and good harvest. Weather changes and higher commodity prices, if it happens, may exert some upward pressure on the price level. CPI inflation for 24-25 is placed at 4.50%, and Q3 at 4.80%, and 4.20% for Q4. Core inflation remains stable and within the policy target levels. On growth, real GDP growth for 2024-25 is projected at 7.20%, Q3 at 7.40%, and Q4 at 7.40%.
As you may be already aware, we have been recommending investments at the long end of the curve, that is, long duration products, through gilt funds and direct bonds since Nov 23. This recommendation continues to be valid as the view on the basic direction of interest rates and market yields has not changed. The fundamental reasons for the recommendation remain unchanged. We would like to reiterate the following.
The inflows into the domestic bond markets on account of index inclusion by JP Morgan Emerging Markets Bond Index, and the further inclusion of government bonds in the Bloomberg Bond Index and the FTSE Russel Emerging Markets Government Bond Index will lead to more inflows over the next one year into GOI bonds. This coupled with a lower quantum of issue of government bonds, and the consequent lower supply, to the tune of approximately Rs.2 Lakh Crs, will potentially present a positive demand scenario for local bonds. These factors will gradually pull down the market yields. This makes a strong case of investments into GOI bonds.
Yet another factor that is positive for gilts is the spread between the Repo rate and the 10 Year GOI Benchmark Yield. On an average this spread is at 100 bps. The highest historical spread was 138 bps, and the least spread was – 38 bps in the last ten years. The Repo rate being a short-term money market rate which the central bank employs to bring about desired changes in the cost of credit, the Repo Rate is crying for a downward adjustment especially with a state of high liquidity in the interbank market. It is imperative that this adjustment should happen sooner than later. This brightens the scope for rate reduction.
