By keeping interest rates unchanged, RBI bats for policy continuity

Increase in bond yields poses a conundrum to policymakers, and unless quickly reined in, could derail growth recovery

The monetary policy announcement was on expected lines. What was pleasant was Governor Urjit Patel’s interaction after the meet, indicating the Reserve 

Bank of India’s (RBI’s) desire to support and nurture an incipient recovery, despite some possible upside risks to inflation. This clearly had a soothing impact on debt markets that have been plagued by glorious idiosyncrasies ever since the RBI cut the repo rate in August 2017. 

The increase in bond yields poses a conundrum to policymakers, and unless quickly reined in, could derail the growth recovery. Several reasons have been propounded for such a massive rise in yields, including fiscal slippage, rise in oil prices, and the global rise in yields. However, the truth possibly lies elsewhere. For example, while it is true that global bond yields have rallied significantly in the last couple of days, a cursory look at the data (see table) indicates the rise in yields in Indian markets are out of sync with macro fundamentals. 

As a rule of thumb, if we take the maximum increase in yield (42 basis points) for emerging and developed economies from July 2017 — when the yields started rising globally — as the proxy for our yield increase, then the Indian 10-year yields should have been closer to 7 per cent now. The sad thing is that in countries doing worse than India in terms of macro fundamentals and stability, such as Russia and South Africa, the bond yields have declined on an average by around 42 bps in the same period. Needless to say, such high yields push up government borrowing costs and are surely inimical to monetary policy transmissions, as this puts upward pressure on bank marginal cost of funds-based lending rates (MCLR).

Regarding fiscal slippage, though the government has shifted the goalpost, the fact is that given the spate of cancellations in auctions, the gross market borrowings in FY18 could end up lower than budgeted. Also, net market borrowings in FY19 are supposed to be lower than in FY18 by Rs 120 billion. 

On oil prices, the RBI admitted the movement could be two-way. Thus, it is high time that the debt market corrects from distortions with facilitation from the regulator. For example, the RBI has to take a conscious call for a trade-off between injecting transient liquidity and enduring liquidity that is growth-supportive. 

The monetary policy also contains several innovative measures to support the micro, small and medium enterprises (MSME) sector and centralising the benchmark rates through Financial Benchmark India Ltd (FBIL). 

Finally, a word on the current global rout: The factors that have contributed to this include a self-contradictory strategy of easy fiscal policy and tightening monetary policy in the US. To add to this, both household debt 

and non-finance corporation debt have increased rapidly, making S&P raise the alarm that the current tightening cycle will end up increasing default rates. 

Over 2011-17, global non-financial corporate debt grew by 15 percentage points to 96 per cent of gross domestic product. Thus, if the US Federal Reserve continues its path of normalisation, there could be a drag on consumption due to the negative wealth effect of fall in equity prices.