 "RBI, reserve bank of india")
It’s a long hiatus in rate cut for the monetary policy committee (MPC) of the Reserve Bank of India (RBI) after the surprise headline inflation print at 7.35 per cent, way above the central bank’s target of keeping the number limited between 2 and 6 per cent.
The Monetary Policy Committee (MPC) under RBI Governor Shaktikanta Das cut policy rate by 135 basis points since February before it decided to take a pause in December. Now, economists and the bond market participants say such pause would be extended for sure in February, as well as in April policy, as it will take some more time for the vegetable prices to cool down. And even if onion prices fall sharply due to import and fresh crops, the base effect will keep the print on the higher side.
But economists are not unduly worried about the spike in inflation.
“Half of the headline number is vegetable prices, led by onion. Everything else is following largely their long-term seasonal pattern. The issue, though, is that even as the month-on-month momentum in vegetable prices moderates going forward, the base effect will keep the headline print high. In January, the CPI inflation will likely cross 8 per cent,” said Gaurav Kapur, chief economist of IndusInd Bank.
He said the MPC would have to look through it considering the core inflation remains stable at 3.7 per cent.
For the bond market, it is a new trouble. The market was expecting inflation to rise, but not this much.
“Bond yields will be under pressure. The 10-year bond yields can go up by 10 basis points in the opening trade, but will trace back, and go up again. Much depends upon how the RBI manages the situation through new instruments,” said Jayesh Mehta, head of treasury at Bank of America.
According to bond dealers, it is certain that the RBI will have to conduct more open market operations (OMOs), in which it buys and sells bonds from the market. But at the same time, RBI’s ability to support economy, growth, and liquidity is somewhat restricted after the MPC.
The central bank on Monday said the government converted bonds worth Rs 41,920.230 crore. The transaction involved buying back securities maturing in FY21 from the RBI and issuing fresh securities for equivalent market value, to make the transaction cash neutral. This will help the central bank do more operation twist kind of operation where it sold short term securities and bought long-term securities to correct the yield difference between the two maturities.
The market doesn’t expect the policy stance to change from accommodative to neutral, as the stance would be dependent upon a pickup in growth from its current 5 per cent level.
But the central bank can still cut rates, while giving a signal that it is cautious about the inflation, and thus change the stance anyway, some say.
“Should we read this steep rise in inflation print was preempted by the long bond yield spread, then inflation expectations and high bond spread was warranted. To anchor the spillover risk to general basket, the RBI could change its stance to neutral,” said Soumyajit Niyogi, associate director at India Ratings and Research.
But it is a difficult situation to maneuver for the RBI nevertheless.
“The RBI is now faced with most daunting task of solving “impossible trinity” — high fiscal deficit, higher inflation, and lower for longer rates conundrum,” said Kunal Valia, an independent bond market expert.
“Just like any central bank around the globe, the RBI may tread the path of lower rates to support a slowing economy and may live with higher inflation for few months,” Valia said.
