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Monetary Policy Review

Dec 7, 2016

Policy Action: Rates unchanged at 6.25%; accommodative stance continues

Under the second review of the newly formed Monetary Policy Committee (MPC) of the RBI, the key policy repo rate was unchanged at 6.25%; which was decided unanimously by all the 6 members. The policy tone remains accommodative, with the MPC reiterating the CPI target of 5% by Mar’17 while the medium term CPI target remains at 4% within a band of ±2%, while supporting growth. The next bi-monthly monetary policy statement is scheduled for February 7, 2017.

  • RBI’s independence re-affirmed
    The action addresses any concerns investors may have had about the independence of the RBI from the government.
  • RBI’s core focus will be inflation over growth
    In what appears to be a continuation of Gov. Rajan’s inflationary focus, the MPC headed by Gov. Patel also appears to be continuing down the same inflation targeting framework. Despite our disappointment on the rate decision, an inflation targeting framework is without question the right strategy from a structural, long term benefit perspective.
  • RBI chose global factors over domestic disruption
    The RBI chose to essentially ignore the domestic demand disruption, supply chain disruption, hardships and confidence shock that the populace is currently experiencing. The majority of the economic forecasting community was expecting the RBI would acknowledge the significant hardship that the majority of the public has experienced.
  • Withdrawal of CRR on December 10, 2016 a welcome announcement for banks
    The withdrawal of the CRR will enable banks to deploy surplus funds into income generating assets, which would most likely appear to be government bonds, as well as injecting liquidity into the system.
  • INR 11.55 Cr collected to date, still early to form conclusive opinion on demonetisation exercise
    With roughly 74% of high currency notes back at the banks, it is difficult to project the pace at which additional deposits will make their way into banks through the end of the month. We’d also note that the discourse has moved away from black money to a less cash society over time. However, evidence is certainly starting to mount that the execution could have been handled more effectively.
  • Special dividend to the Government
    The Governor did not provide details on the balance sheet treatment of the extinguished liability of demonetised currency. However, he squashed any possibility of a special dividend being issued to the government at least in the shorter term.

Implications & Outlook

The RBI could have offered a fig leaf to a beaten down populace, but chose to ignore short term disruptive shocks in the domestic economy, focusing instead on high frequency upticks in core inflation, a rise in crude oil and prospects of a global recovery.

The 10 year spiked by 21 bps to 6.39% post the announcement. While there could be a downward bias in coming days as a result of the incremental CRR being removed, it appears that we’re nearer the end of the strong move lower in rates in the near term. Moving forward, we’re envisioning an environment where neither the foreign institutional investor nor a good part of the domestic debt investor today is particularly compelled to invest in a lower yielding G-Sec.

We advised investors in our commentary last week to move higher up the rate structure. We continue to advise debt portfolios structured around medium term accrual funds, income funds, a diversified portfolio of corporate bonds, select AT-1 bonds and select preference shares.