‘We expect policy repo rate at 5.75-6.00% by March 2023’

The RBI sprang a major surprise by doing an unscheduled Monetary Policy Committee (MPC) meeting over 2-4May and raising the policy repo rate by 40 basis points and CRR by 50 basis points, instead of waiting for the June meetings as was widely expected.

The key highlights of the announcement were:

  • MPC voted unanimously to raise repo rate by 40 bps in an unscheduled meeting
  • MPC maintained the accommodative stance while focusing on withdrawal of accommodation
  • RBI raises CRR by 50 bps to 4.50% effective May 21, 2022
  • MPC expects inflation to rule at elevated levels, warranting resolute and calibrated steps to anchor inflation expectations and contain second round effects

MPC statement:
The MPC noted the surge in headline CPI in March to 7%, along with the rapid rise in inflationary pressures across the world. Thus, there is a significant upside risk to the inflation trajectory set out in the April statement. Since the April meeting, disruptions, shortages and escalating prices induced by the geopolitical tensions and sanctions have persisted. Global commodity price dynamics are driving the path of food inflation in India, including prices of inflation-sensitive items that are impacted by global shortages. The risks to the near-term inflation outlook are rapidly materializing, as reflected in the inflation print for March and the developments thereafter. Thus, the MPC expects inflation to rule at elevated levels, warranting resolute and calibrated steps to anchor inflation expectations and contain second round effects

While prioritizing Inflation over growth in the April Policy, RBI had set the stage for normalization of monetary policy but nobody expected that words will pave way for blunt action so soon, less than a month after the April 8th MPC meeting.

Deciphering this surprise action from the RBI, it seems to us that the RBI has got concerned about inflation domestically after the March inflation print, as highlighted in their statement. In all likelihood, the April CPI print is also going to be much higher than market anticipation and the trajectory of inflation will stay elevated, which in our view, led to this surprise rate action by the RBI. Moreover, in the last one month, we have seen some aggressive communication from Central banks in developed markets regarding the need for an appropriate response to inflation. Worldwide yields have surged as markets started to factor in monetary tightening amid sticky and elevated inflation levels.

Market reaction and outlook
The curve flattened significantly even as yields rose across the curve. One-yr Overnight Index Swap (OIS) has risen 100 bps with the 5-yr OIS rising by 45 bps. The yield on the benchmark 10-yr Bond has risen 30 bps to 7.40%

We expect the 10-yr yield to be rangebound between 7.25%-7.50% in the next few weeks as the sharp upmove in yields to 3-year highs is likely to generate some demand.

We expect the RBI to continue to frontload rate hikes and see the policy repo rate at 5.75-6.00% by March 2023.

We expect widening of corporate bond spreads over sovereign over the next 3/6 months as they have fallen to historically low levels on the back of lack of supply and surplus liquidity and now as the RBI is becoming proactive in liquidity management, we expect corporate spreads to widen.

We would recommend Investors to stay invested in actively managed short-duration funds and can look to increase their investment as yields rise. We would also recommend investors with longer investment horizon (> 3yrs) to start investing in actively managed long-duration funds as yields are becoming attractive from a long-term perspective.

(The author is the the Head-Fixed Income, PGIM India Mutual Fund.)


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