RBI hints at policy normalization. What it means for debt market investors?

On an expected line, RBI on Friday decided to keep the policy repo rate unchanged while maintaining an accommodative stance, however, it restored the liquidity corridor position to the pre-pandemic level. Due to geopolitical tension that led to mounting commodity prices along with boiling oil prices, RBI now expects a slowdown in economic growth while inflation to rise further.

The RBI's policy approach in the first bi-monthly monetary policy for FY23 is hawkish. The current monetary policy is expected due to the inflationary pressures globally. However, post this RBI policy, bond yields are seen to stubbornly rise furthermore.

In April 2022 monetary policy, RBI keeps the repo rate unchanged at 4%, while the marginal standing facility (MSF) rate and the Bank Rate also remained unchanged at 4.25%. However, maintaining its approach for liquidity adjustment facilities, i.e. LAF corridor normalization, the central bank introduced a standing deposit facility (SDF) rate, which will now be the floor of the LAF corridor, at 3.75%.

Further, among its major developments, RBI increased the limit under Held to Maturity (HTM) category from 22% to 23% of NDTL till March 31, 2023. The move is to enable banks to better manage their investment portfolio during 2022-23.

Also, RBI decided to allow banks to include eligible SLR securities acquired between April 1, 2022, and March 31, 2023, under this enhanced limit. The HTM limits would be restored from 23% to 19.5% in a phased manner starting from the quarter ending June 30, 2023.

Prashant Pimple, Managing Director & Chief Investment Officer – Debt, JM Financial Asset Management said, "Hold to maturity (HTM) limit for banks stands enhanced by 1% up to March 31, 2023, with an intention to support government borrowings for this financial year. The policy corridor has been normalised through SDF and MSF. No clarity on the absolute quantum of open market operation acted against Gsecs with the benchmark 10 years moving above 7%, post-policy."

Abheek Barua, Chief Economist, HDFC Bank said, "The RBI has responded to both the new inflation and growth challenges that have emerged due to geopolitical tensions that have manifested themselves in rising commodity prices. While the RBI kept its monetary policy stance unchanged, it restored the policy corridor to pre-pandemic levels and provided a commitment towards a slow reduction of liquidity going forward."

"This is clearly a hawkish policy as compared to the February meeting, justified by the inflationary pressures that have emerged over the past month. The upward inflation forecast revision by 120bps to 5.7% for FY23 seems sensible given the broad-based nature of price increases," Barua added.

RBI in its policy on bond yields said, several central banks, especially systemic ones, continue to be on the path of normalisation and tightening of monetary policy stances. Resultantly, sovereign bond yields in major AEs have been hardening. Bullion prices had buoyed to near 2020 highs on safe haven flows, with some recent correction as bond yields rose. 

RBI went on to explain that global equity markets fell, although more recently they have recovered some ground. In recent weeks, strong capital outflows from the EMEs have moderated thus curbing the downward pressures on their currencies, even as the US dollar has strengthened. 

“Overall, the global economy faces major headwinds from several fronts, including continuing uncertainty about the pandemic’s trajectory,” RBI said in its policy statement. 

Going forward, Barua said, "Despite the increase in HTM limits, bond yields are likely to go up given the sheer size of the borrowing program for FY23. We expect the 10 years to rise to 7-7.25% in H1 FY23.”

On inflation, RBI expects the consumer price index at 5.7% in 2022-23, with Q1 at 6.3%; Q2 at 5.8%; Q3 at 5.4%; and Q4 at 5.1%. While the real GDP growth for 2022-23 is now projected at 7.2%, with Q1 at 16.2%; Q2 at 6.2%; Q3 at 4.1%; and Q4 at 4%, with risks broadly balanced.

Dr. V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services said, "Recognising the new reality of higher crude triggered by the war the RBI, as expected, reduced the FY23 GDP growth rate projection to 7.2 percent from 7.8 percent earlier and raised the CPI inflation projection for Fy 23 to 5.7 percent from 4.5 percent earlier. This is based on the assumption of crude at $100. This implies that growth and inflation can be better if crude declines sharply if the war hopefully ends early. The reverse can be true if the war aggravates and crude spikes much above $100."

"The MPCs decision to maintain its status quo is in line with expectations. RBI has emphasized on the strong buffers of forex reserves, which may act as a cushion amidst geopolitical tensions and exchange rate volatility," Shivam Bajaj, Founder & CEO at Avener Capital added, "The reaction of the market on the downward revision in growth rate to 7.2% and an upward revision in inflation rate to 5.7% is to be kept an eye on. It will also be interesting to see how the economy tackles its supply-side constraints to mitigate the inflationary pressures."

Rajeev Radhakrishnan, CIO-Fixed Income, SBI Mutual Fund said, "RBI continues to chart a course diametrically opposite to what most Central Banks have been doing. A status quo on rates and guidance was accompanied by the governor’s statement that continued to stress on continued policy support to ensure broad based and durable growth, along with continued reference to the impact of the pandemic. A few procedural changes on the liquidity framework were accompanied with no clear guidance on unwinding durable liquidity."

Radhakrishnan added, "While the near-term impact has been an easing in rates with a curve steepening bias, continued reluctance to acknowledge a shift, in the context of changing dynamics both globally and with recovering domestic growth remains surprising. In this context, continued volatility in market rates remains the base case as there seems no clear fundamental reason to validate lower rates, except continuing dovishness and lack of pre emptive policy normalisation actions by the central bank."