Credit Policy & Inflation forecast by RBI

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The Central Bank decided to continue with its neutral stance, as well as hold Repo Rate at 6.25%, in its recent monetary policy review on the 6th of April.

However, it raised Reverse Repo rate to 6%, to better align the short- term money market rates to the Policy Rates. Besides, it upped its inflation forecast stating that CPI inflation would average at 4.5% in the first half of the year and 5% in the second half. This led to a sell off in the Government Bond markets, with yield on 10 Year paper moving up by 20 bps to 7%.

Our take is that inflation in the coming months will be lower than what the central bank is forecasting. This along with the consistent hawkish stance by the central bank will further squeeze out inflation and inflationary expectations from the system. Thereby creating an excellent buying opportunity in the longer duration Fixed Income Papers.

Further, the macro environment too is supportive of bond prices, such as lower current account deficit (0.5%) along with a robust currency. In this context one should further note that corporate credit off-take still remains muted. At the same time, strong Fiscal discipline demonstrated by the Central Government is a support factor, though higher deficit by the State Governments is of some concern.

While there is some risk of inflationary pressure arising from the below average monsoon that is expected this year, we feel that the inflation numbers in the coming months and also during the year, will be largely contained in view of the following factors:

  • High base effect: The sharply rising price levels from March to July 2016, will lead to lower headline inflation numbers in the next few months because of the base effect. Price level (CPI) increased from 126 in Feb / march 2016 to 131 in July 2016 and has remained flat thereafter and the reading for Feb 2017 was 130.5
  • Global oil & commodity prices have witnessed a sharp rally in the past one year and are unlikely to see significant upside movement hereon. Besides, the exceptionally strong Indian currency will absorb impact of price rise if any
  • While, there is some talk of Goods & Services Tax being inflationary, we do not anticipate any significant inflationary impact on this account, as the new GST regime will maintain revenue neutrality. We also do not buy into the argument that during the initial period of GST launch, producers may not pass on the full impact of input credit benefits, leading to inflationary pressures.Pharma sector.

In summary, we feel that the outlook over the next three to six months for longer duration fixed income papers is bright.

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