A security guard stands at the gate of the Reserve Bank of India (RBI) headquarters in New Delhi, India. (Photographer: Anindito Mukherjee/Bloomberg)

Policy Day Guide: MPC Set To Begin New Financial Year With A Status Quo On Rates

The monetary policy committee will meet today to set course for the new financial year. The economy is entering the new year on a steady note, with growth rebounding and inflation remaining moderate. As such, most economists expect the MPC to maintain the benchmark rate at 6 percent and also maintain a neutral stance, which allows it to move in either direction should economic indicators turn.

Goldilocks Economy

The Indian economy is expected to have grown at a stronger pace in 2018-19, as disruptions due to the introduction of the Goods and Services Tax settled down. Despite continued volatility in some high frequency indicators like the manufacturing PMI, most economists believe that the economy is recovering steadily.

The MPC, in February, projected gross value added growth at 7.2 percent in the financial year 2018-19. Devendra Pant, chief economist at India Ratings believes growth will be a touch stronger at 7.4 percent compared to an earlier estimate of 7.1 percent.

“From the production side, higher growth in agriculture (expectation of normal rainfall and assumption of even rainfall distribution over space and time) and industrial sectors is expected to push the overall economic growth,” Pant wrote in a report on Wednesday.

The rebound in growth is coming alongside moderate inflation, so far. Retail inflation in February came in below estimates at 4.4 percent. Some economists believes that FY19 inflation will also be below the RBI’s forecast. “The path of inflation is also likely to be lower than MPC’s February ’18 forecast range of 5.1-5.6% in H1FY19 and 4.5-4.7% in H2,” wrote Saugata Bhattacharya, chief economist at Axis Bank in a note on Wednesday. According to Bhattacharya, inflation driven by increases in house rent allowance have been lower than expected. He, however, added that there are significant risks of inflation moving higher.

These risks may mean that the MPC will remain watchful and ready to raise rates during the course of the year. At the last meeting, one of the six committee members had voted for a rate hike. Markets will be watching to see if any more members move into the rate hike camp or if the MPC’s stance moves away from neutral.
Policy Day Guide: MPC Set To Begin New Financial Year With A Status Quo On Rates

Keeping The Bond Party Alive

The bond markets are looking much calmer than they were ahead of the February policy. After a sharp spike between September 2017 and mid-March 2018, bond yields have eased considerably. The government’s decision to cut borrowings for the first half of the year and the RBI’s decision to let banks spread out mark-to-market losses have helped yields cool off.

Still, liquidity concerns persist. Deposit growth has fallen while credit growth has held steady, meaning banking liquidity has swung between neutral and deficit. At the same time, the pace at which currency in circulation is rising has also picked up.

The RBI has said it will provide liquidity support as needed but has stayed from bond purchases via open market operations. As such,  bond market participants will be watching for any commentary that suggests RBI is willing to inject durable liquidity.

“Our liquidity model estimates that the RBI will need to inject about $37 billion in FY19 to sustain 6 percent old series GDP growth,” wrote Indranil Sen Gupta, India economist at Bank of America Merrill Lynch in a report this week. He expects Thursday's policy to further recent steps by the RBI and the government to contain bond yields.

Policy Day Guide: MPC Set To Begin New Financial Year With A Status Quo On Rates

Red Carpet For Foreign Investors?

Markets are also watching to see if the RBI yields to calls for a higher foreign investment limit in government and corporate bonds.

In September 2015, the RBI had announced a roadmap to increase the foreign holding in government bonds. At the time, it had said that the foreign investment limit would be raised to 5 percent of the outstanding government debt in tranches by March 2018. That roadmap has run its course.

Should the RBI decide to raise the foreign investment limit further, it will likely do so in tranches over a period of few years as it has in the past.

In the corporate bond segment, the foreign investment limit has not been raised for the last five years. Both the foreign investment for government bonds and corporate bonds is completely used. Some limit is still available for long term investors like sovereign wealth funds and pension funds.

A key consideration in raising the foreign investment limit will be the potential for volatility in global interest rates at developed Market central banks continue to normalise monetary policy. The RBI may be tempted to protect the domestic markets from such volatility by keep limits unchanged.

Policy Day Guide: MPC Set To Begin New Financial Year With A Status Quo On Rates

Banking Sector Concerns

Bankers will be listening closely for any comments on bad loans and allegedly poor governance practices at some private banks.

Since the last post policy press conference, a near $2 billion fraud has been detected at Punjab National Bank. Concerns have also emerged of alleged conflict of interest in loan approvals by ICICI Bank to Videocon Industries.

In February, the RBI also announced a new stressed asset framework, which is likely to lead to a spurt in reported non performing assets in the coming quarters.

Any comments by governor Urjit Patel and his team on bad loans and banking governance would be closely watched.

Separately, the RBI may also finalise the new benchmark to which loan pricing has to be linked starting the new financial year.