First thoughts on the monetary policy
There was a sense of optimism in the RBI governor’s speech and they finally laid out their GDP projections. They are expecting GDP to contract by 9.5% year-on-year which is quite realistic but I am surprised that they are expecting a positive GDP growth in the fourth quarter which definitely looks optimistic at this point in time. At the same time, RBI is clearly saying that what we are seeing on inflation is more like a supply side disruption and that should be easing by the fourth quarter which is exactly in line with our estimates. Even though we expect a status quo in today’s policy, we are of the view that there is still space open for 25-50 bps policy easing in the rest of FY21.
Lastly, what is more interesting for the markets are the liquidity operation measures. They clearly have increased the size of the OMO operations. They are ready to provide enough liquidity through TLTROs (Targeted Long Term Repo Operations) and they stand ready to do open market operations. I guess the bond market should be happy.
RBI is trying to balance the objectives of pumping in enough liquidity while not announcing a direct monetisation of debt. They are trying to manage the bond market fears by doing active open market operations. I would say we are looking at 10-year bond yield remaining supportive to well within 6% for this year and we see space for another 25-50 bps in the rest of FY21.
On allowing OMOs in state development loans
The government’s fiscal position is still very challenging even though when the borrowing programme was announced and the government stuck to the borrowing limit, the markets were relieved. Everyone is worried that this is not the end of it and by December-January, you could see a higher borrowing pressure coming in.
Anything from the RBI on the funding side was very important just to ensure that the bond market is calmed, especially from a longer term point of view. I am here talking about a 10-year beyond and not really a short term market yield which is more affected by liquidity or the policy interest rates. In that sense, coming out very categorically on OMOs, the size of OMOs or even talking about FBL being funded through OMOs is a very good thing but the market will definitely be looking for more measures and the extent of OMOs that RBI will be willing to do.
For instance, barring that Rs 1.3 trillion of OMOs already conducted, so far our expectation is that India needs at least Rs 2.5 trillion of OMOs to be able to fund the fiscal deficit smoothly. Other than that, there could be funding pressure on the bond market and it could lead to a rise in bond yields. This is just a step. The market will be looking for a continuous momentum, with regards to normalcy and support given by the RBI that the markets do not need to worry and we are ready to provide and pump in liquidity and doing open market operations or Operation Twist.
We need a continuous commitment that it is not just a one time thing. Whether the OMO size will additionally go up by Rs 2.5 trillion is something we need to see over the coming months. Our personal view is that the fiscal challenges are far from over. India needs a much more credible and significant fiscal push whereas what we have seen so far is quite a conservative moderate number even though RBI governor is sounding very optimistic that the Q4 GDP could be positive.
I think the recovery on ground is going to be very gradual. There are still a lot of uncertainties related to overall income levels, job situations which are going to have a big macro impact over the coming quarters. So yes, it is good news that RBI is standing ready to pump in liquidity, provide support to the bond market by increasing the size of OMOs.
We need a continuous policy push to ensure that the bond yield concerns are taken care of and it is very critical to see how the fiscal situation pans out over the coming months and if GDP actually surprises on a positive growth in Q4 as the RBI governor is expecting.