The MPC delivered a 25 bps cut as widely expected in an equally widely anticipated policy, since this was new Governor Malhotra’s first. To that extent, market participants including ourselves were keenly looking out for some indication on the Governor’s line of thinking, while always appreciating the importance of institutional continuity. Thus, we start below with some takeaways from the Governor’s statement. A risk worth pointing out is that of over-reading, or looking for clues that aren’t there.
1. The Governor noted the flexibility embedded in the mandate when responding to evolving growth-inflation dynamics. To that extent, if market needed clearer signals that an actual durable attainment of the exact 4% target is not required for monetary easing, then that was delivered. Frankly, here is the risk of over-read since this was always the case in our view. Thus, the current set up of slowing growth and inflation visibility towards ‘4-handle’ would have invited the same reaction function from the previous regime as well. Alongside there is emphasis in improving data and analytics which, as with any other organization, could very well represent a fresh pair of eyes looking at the whole process.
2. The commentary on regulatory front, especially pertaining to the proposals specifically mentioned in the statement which have been a subject of considerable discussion, seems also somewhat of a tweak in perspective with the Governor assuring not just consultation but also considering the trade-offs between stability and efficiency. The most obvious read of this looks to us a consideration of not unduly burdening the system even as one looks to not compromise on stability. Indeed, the Governor clarified in the press conference that the Liquidity Coverage Ratio (LCR) guideline revisions will not be applied at least till March 2026. No timeline was given for expected credit loss norms while the Governor also indicated a deferment of the project finance guidelines.
3. The Governor also committed to provide ‘sufficient system liquidity’ and continuing to monitor evolving conditions and ‘proactively take appropriate measures to ensure orderly liquidity conditions’. With the number of measures taken thus far, and the Governor’s assurance even in the press conference that RBI will remain proactive, the market does have overall comfort that RBI will likely be more proactive than before. However, participants are left guessing whether ‘sufficient’ and ‘orderly’ mean surplus liquidity conditions or not. This point is important since sustained transmission may require a surplus liquidity environment.
General Takeaways
We continue with our preferred statement in terms of ‘constraint optimisation’ when evaluating macro policy. The constraint from a hawkish external environment was clear in the stance being retained even as optimisation was attempted with a rate cut. With CPI expected to average 4.2% for the next financial year, an April or at worst June cut is also very much on the table provided the global environment allows for it.
Market’s near term disappointment is with respect to the absence of new liquidity measures. Our estimates indicate that the cumulative measures undertaken thus far may still fall short of making core liquidity turn positive, given ongoing seasonal currency in circulation increases as well as continued dollar sales by RBI. The assurance on further measures as needed, including on durable liquidity injections, will help.
That said, the absence of ‘here and now’ new measures does create a window of uncertainty during what is peak busy season on credit levying maximum pressure on lenders’ resources. Further, as mentioned above, the important distinction between ‘sufficient’ liquidity and ‘surplus’ liquidity remains as yet unclarified. This may keep deposit rates under pressure for now. However, from next quarter as credit ‘lean’ season begins and core liquidity improves further, including from an expected hefty RBI dividend, the transmission process can commence in a more broad-based fashion. Drawing from this scenario, we will look for RBI announcing new ‘liquidity bridging’ measures between now and May.
Market Implications
With disappointment today on incremental liquidity measures, the front end of the non SLR curve may remain under pressure for now. However, with the next rate cut still in play, liquidity expected to improve from next quarter, alongside the setting in of lean season on credit, we believe that investors should use this opportunity to continue building front end non SLR investments; including in money market instruments.
Government bond yields have risen in first reaction to the policy but this largely reflects market positional loading in anticipation of booking profits post policy. Apart from the next rate cut expectation being still alive, RBI bond purchases continue, and the government has recently reiterated fiscal discipline. We continue with our preference for government bonds in running duration. An important outcome from the RBI policy today was also the announcement of the bond forward guidelines that will incrementally strengthen demand for long term government bonds. We had recently discussed the dynamics here including our continued bullish stance with respect to long duration government bonds (https://bandhanmutual.com/article/20748).
Source: RBI and Bandhan Internal Research
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