RBI monetary policy wears a party hat for bonds and banks
Why play party pooper when you are running out of reasons to do so? That is what the Reserve Bank of India (RBI) seems to have realized and done at the monetary policy meeting on Thursday when it slashed its retail inflation forecast by a big margin.
The fact that the inflation forecast would be lowered was broadly expected. But that it would be lowered for 2018-19 in entirety by as much as 30 basis points was unexpected.
Retail inflation is now expected to have dropped to an average 4.5% during January-March instead of the 5.1% the central bank forecasted in its February policy. With vegetable prices behaving and crude oil prices having run out of steam for now, holding on to a scaremongering inflation forecast was futile. Preliminary data for the month of March also suggests that food inflation could remain benign until June. That means retail inflation could be 4.7-5.1% in the first six month of 2018-19 instead of the earlier forecasted 5.1-5.6%. RBI is betting that a normal monsoon and waning effects of house rent allowance will keep inflation around the central 4% mark of the flexible target range of 2-6% in 2018-19.
This is where the discomfort sets in. The central bank has listed a number of upside risks from increase in farm support prices to fiscal slippage and even global crude oil prices. The minimum support price hike effect will be visible during the kharif harvest months that fall in the second half of the fiscal year. Crude oil prices are biased on the upside. A pickup in domestic demand would only accelerate in the second half of the year given the seasonality of consumption during festival months. By pruning its forecast for the second half, RBI has set itself up for a revision again.
What these forecast cuts have done is fired up the bond market that was already pleased with a lighter supply load. Bond yields dropped 16 basis points on Thursday and could fall more.
RBI was not only sanguine about inflation but growth too. Gross domestic product is expected to grow by 7.4% in the current fiscal year, similar to what the government had said in its Economic Survey. One reason why growth will improve is the fact that bank balance sheets are being fixed with the resolution process under way involving bad loans worth Rs3 trillion under the Insolvency and Bankruptcy Code. Where banks are unable to stitch their books together, RBI has offered help by allowing them to spread their bond portfolio losses over four quarters. At the policy, the central bank offered another relief. It postponed, the implementation of Ind-AS accounting norms that would have piled on more provisions on lenders and thus pushed them deeper into losses.
It is no surprise that banking stocks extended their rally, with banking indices gaining nearly 3%. The risks of inflation rising are still there but for now RBI has donned its party hat for bond traders and bankers.