POST POLICY PULSE - Rates unchanged but monetary easing not over

Pre policy action steals limelight from the policy

n         The Reserve Bank of India (RBI) since Q4 CY08 has initiated various conventional and unconventional measures registering the quickest change in stance and possibly the smallest interest rate cycle - the apex bank reversed the four-year elongated hawkish stance in a meager three months (Q4 CY08). After a steep cut on January 2, the apex bank left all rates unchanged in the Third Quarterly Review of monetary policy on January 27.

 

Impact analysis

While all monetary and fiscal measures were concentrated in Q4CY08 (pre and post October 24 policy) they had a significant impact on the fixed income segment:

1. G-sec posted a ~450bps rally to an all-time low of 4.86%.
2. Corporate bonds gained additional ground compared to their sovereign counterparts as they trailed G-secs and spreads also compressed by ~100bps.
3. Lucrative low rates: Primary issuers flocked to the debt market as other avenues dried as well as for the significantly low borrowing cost.
4. With cash rich vaults and lower borrowing cost, CDS of banks and corporates trading in off shore markets eased from their October highs.
5. Swap market knows it all: Steep fall in swap rates by ~500bps to sub-5% levels factoring in further rate cuts and buoyant cash conditions.
6. Dual fiscal blow: Additional spending led to additional borrowing; total government borrowing for FY09 touched INR 2.15 tn (budgeted INR 1.45 tn).
7. Shortfall to surplus: In a matter of three months, CRR injected 1.6 tn; from a shortfall of INR 1 tn in October 2008 we have ~INR 0.5 tn in LAF reverse repo.
8. Lazy banking: Funds flow to greener (safer) pastures. Risk aversion by banks has induced them to prioritize SLR (risk free) investment over corporate lending.

 

Silent policy leaves participants guessing

While the central bank on January 27 left all key rates unchanged, it briefly signaled future calibrated, swift, and effective monetary measures to minimise the impact of the crisis on the already slowing economy. Some of the key takeaways of the statement are:

n         RBI has recognised that growth has slowed down and also revised down its GDP estimate to 7% with a downwards bias. Also, credit growth target has been revised upwards to 24%, indicating that further softening of policy rates is required to revive the economy and compelling banks to shore-up lending.

n         Words like "swiftly, effectively and decisively" indicate a lower probability of big-bang cuts witnessed over the past three months.

n         With too much emphasis on comfortable liquidity and also acknowledging that the entire effect of CRR cut is with met with a lag effect of 4-6 months, further liquidity boost by way of pruning the reserve ratio in the near term would have a lower probability. MSS buy-back along with refinancing is likely to serve the purpose of injecting liquidity.

n         Unlike the previous policy, where only a week after the policy the RBI had slashed rates by 100bps, this time further measures will depend on the release of macroeconomic data. We are unlikely to witness immediate measures as the RBI believes that results of actions taken over the past several months are still to unfold.

n         The bond market had completely priced in such a move (silent policy); and, therefore, significantly reduced (only event-based) volatility is expected. 10-year benchmark is expected to witness sideways trading near current levels with an overall downward bias. Despite supply worries being one of the major negative factor the benchmark yield is expected to test the 5.60-5.75 levels in near term; any further decline needs to be fueled by a rate cut or its rumor.

 

Overall, it is a perfect 'wait-and-watch' policy where any further measures will only be subject to how macroeconomic indicators develop over the next quarter. While the slackening domestic growth and downside risks to IIP advocate further rate cuts, lagging impact of previous cuts will influence RBI to buy some time before the next move. Though rates have not been changed, this cannot be interpreted as a neutral stance and further easing would be on the cards to ensure that we are still in a bond positive market.