#39;Rate cut unlikely in Feb MPC meet; key risk factor continues to be potential overshoot on fiscal side#39;

December 07
17:29 2019

Lakshmi Iyer

The Monetary Policy Committee (MPC) on December 5 voted to keep the policy repo rate, under the liquidity adjustment facility (LAF), unchanged at 5.15 percent even while maintaining the accommodative stance.

This is in contrast to the market and our expectations of a 15-25 bps cut in rates. As per the policy statement, the decision is in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent. All the members of the MPC voted in favour of keeping rates unchanged.

It was natural for bond yields to spike by 10-15 bps across the curve, as rate cut was almost priced into bond yields. 10-year benchmark government bond yield is at 6.60 percent (up from 6.45 percent levels pre-policy)

The key projections of the RBI are as under:


– In the fourth bi-monthly resolution of October 2019, CPI inflation was projected at 3.4 percent for Q2FY20, 3.5-3.7 percent for H2 2019-20 and 3.6 percent for Q1FY21 with risks evenly balanced.

– The actual inflation for Q2 evolved broadly in line with projections – averaging 3.5 percent. The inflation print for October, however, was much higher than expected.

– The CPI inflation projection is thus revised upwards to 5.1-4.7 percent for H2 2019-20 and 4-3.8 percent for H1 2020-21, with risks broadly balanced.


– The real GDP growth for 2019-20 in the October policy was projected at 6.1 percent – 5.3 percent in Q2FY20 and in the range of 6.6-7.2 percent for H2 2019-20 – with risks evenly balanced; and 7.2 percent for Q1FY21.

– Real GDP growth for 2019-20 was revised downwards from 6.1 percent in the October policy to 5 percent, 4.9-5.5 percent in H2 and 5.9-6.3 percent for H1 2020-21.

Transmission of policy rates

– As against the cumulative reduction in the policy repo rate by 135 bps during February-October 2019, transmission to various money and corporate debt market segments ranged from 137 bps (overnight call money market) to 218 bps (3-month CPs of non-banking finance companies).

– The 1-year median marginal cost of funds-based lending rate (MCLR) has declined by 49 basis points. The weighted average lending rate (WALR) on fresh rupee loans sanctioned by banks declined by 44 basis points.

Measures related to banking

– On Tap Licensing of Small Finance Banks
– Tighter regulations for urban co-operative banks

– Secondary market for corporate loans

Way Forward

– In our view, the pause in rate action has been on the back of near term increase in headline CPI numbers, which may look to recede in the coming months.

– The MPC is likely to see two CPI prints before the Feb policy, which may still be elevated. Hence, the wait and watch stance may continue possibly into Feb 2020 as well.

– By early FY 2021, we could see some reversal in food prices and the path to rate easing could then resume.

– Since the GDP growth is likely to remain subdued over this period, all attention would be on the inflation numbers to decide the policy rate trajectory.

– Key risk factor, as highlighted in the previous note as well, continues to be a potential overshoot on the fiscal side, which could temper some sentiments of the MPC members as well.

– In the tug of war between carry versus potential capital gains, the likelihood of earning carry could gain momentum for now.

– We continue to prefer short to mid end of the curve (1-5 year) which has reasonable anchor due to comfortable banking system liquidity.

– INR has displayed some resilience and is likely to remain stable in the near future. Comfortable Fx reserves to come to the rescue of INR should there were to be a rout on EM currencies.

– Preference to stay invested in non-liquid scheme category funds continues.

– Credits can be looked at selectively, more from bottom-up stock picking, than a top-down sector view.

(The author is CIO (Debt) & Head Products at Kotak Mahindra Asset Management Company)

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