First MPC Policy to Set the Tone for Debt and FX

The Reserve Bank of India's (RBI) policy communique will be more critical than its rate action for the market to ascertain the future path of interest rates, says India Ratings and Research (Ind-Ra). The rupee will stay firm and could trade at 66.35/USD-66.85/USD (66.61/USD on 30 September) throughout the week, while the new 10-year G-sec yield trading range could be at 6.72%-6.85% (6.82% on 30 September).

Communication from RBI and MPC to be Supportive: Domestic bond yields appear to have factored in a rate cut of 25bp in the run up to the policy through the past week. Markets will look for clarity over a few issues: (1) the strategy of the newly-appointed RBI Governor and monetary policy committee's (MPC) action on interest rates, (2) the stance and strategy of the RBI and MPC on liquidity, (3) the real interest rate trajectory and (4) MPC's take on the system-based rate setting approach.

 

Fluctuations in System Liquidity to Dominate: The system may exhibit frictional fluctuations in core liquidity. Ind-Ra's estimates indicate that cash in circulation will increase by around 0.4% of NDTL, draining the interbank system. With the current surplus in system liquidity and RBI's proactive liquidity management, the agency does not envisage any pressure on overnight rates other than frictional volatilities. At the same time, further softening of money market instruments appears limited.

Rupee Volatility May Resurface: The rupee has remained steady barring weaknesses due to intensified tension at India's international border. The rupee is likely to remain volatile through October. For this week, the rupee would largely be driven by sentiment in equity market as well as trade flows.

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