How long will the RBI continue with its extreme accommodative stance?

Status quo expected on Wednesday, but guidance will hold the key for bond market

The Reserve Bank of India (RBI) is expected to hold interest rates for a fifth straight time and maintain an accommodative policy stance after the meeting of its monetary policy committee (MPC) on Wednesday.
 
In the past few policy review meetings, the RBI’s MPC emphasised that the accommodative monetary policy stance would be maintained as long as it was necessary to revive growth on a sustained basis in 2020-21 and into the next financial year. Now, the RBI has to give a new guidance in this first policy of the new financial year.
 
In this context, what the bond market will look for is a guidance on how long the central bank is willing to stay accommodative. “We expect the status quo on policy rates and an accommodative stance and dovish tone to be maintained. No change is expected in growth and inflation forecast,” said Anubhuti Sahay, head of economic research, South Asia, Standard Chartered Bank.

 

“The main focus would be on the forward guidance and timeline around how long they want to maintain an accommodative stance,” Sahay told Business Standard.
 
In particular, the market wants to see if the central bank’s communication on the guidance, whether it wants to make it open-ended by refraining from giving a timeframe or assures that the accommodative stance would remain in force for a particular period.
 
“We expect the accommodative monetary policy stance to remain unchanged not only in the upcoming April policy but at least till the June policy, given the uncertainty posed by the sharp increase in Covid-19 cases within the country which could slow down the pace of the current growth recovery if localised lockdowns become more broad-based in the April-June 2021 quarter,” said Kaushik Das, director & chief economist, India, Deutsche Bank Research.

 
“We expect the MPC to maintain the guidance from the previous policy stating that continued policy support is crucial, till the prospects of a sustained recovery are well secured, while closely monitoring the evolving outlook for inflation,” Das said, adding it was not certain whether the MPC would state categorically that it was ready to maintain an accommodative monetary stance at least till September 2021. But that might become a possibility, he said, if the members assessed the growth risks due to the second wave of Covid-19 to be higher compared with inflation risks over the next six months.

 
The reaction of the bond market after the Budget announcement on February 1 has been a cause for concern at the central bank. In the face of hardening yields since the last policy, the RBI had emphasised on an orderly evolution of the yield curve. Bond yields spiked to 6.13 per cent on February 2, as the borrowing programme announced in the Budget was higher than expected. By comparison, the average yield during April 2020 to January 2021 had been 5.93 per cent. External factors like a spike in the US 10-year benchmark to 1.6 per cent from around 1 per cent and hardening of crude oil prices put further pressure on bond prices and subsequently the yield on the 10-year benchmark government bond reached about 6.25 per cent before softening to close at 6.17 per cent on April 2.

 
The communication
 
Market participants said any talks on normalisation of the extremely accommodative policy stance could make the bond market jittery. RBI Governor Shaktikanta Das assured of another Rs 3-trillion open market operations in the current financial year in view of the large government borrowing programme. In the last financial year, too, the RBI had conducted OMOs of a similar magnitude.
 
“Markets appear sceptical about whether the RBI could steer a course to policy normalisation without a wrong turn,” said Rahul Bajoria, chief India economist, Barclays Research, in a note emphasising an effective communication with the market. The spike in bond yields betrayed the communication gap between the central bank’s liquidity assurance and behaviour of the yield curve.

 
“We believe it can and the MPC meeting on 7 April offers a chance to close the communication gap around how that process may unfold,” Bajoria said, adding the recent spike in India’s rate curve suggested that there lingered doubts on whether the central bank could execute without a policy misstep. “We believe the RBI will likely adopt a very gradual process of normalisation, augmented by moral suasion. Communicating an eventual exit from extraordinary accommodation will be a challenging exercise, with multiple stages,” he added.
 
According to a report by YES Bank, the 10-year benchmark government bond yield is expected to trade between 6.10 per cent and 6.25 per cent in the near term, and approach the 6.50 per cent level by March 2022.

 
The report listed four factors which could weigh on bond prices:
 
i) An increase in discomfort around sticky core price inflation, which is likely to exaggerate further over H2 FY22
 
ii) An increase in global oil prices
 
iii) The possibility of a 25-basis-point rate hike in the fourth quarter of FY21, in case of a durable pick-up in growth momentum
 
iv) And, most importantly, a global risk aversion backdrop amid rising US treasury yields.
 
Growth forecast
 
The current pandemic scenario is completely different from what it was during the previous policy meeting in February, when fresh infections were coming down. Now, the daily cases are going up sharply with a high positivity rate. In such a scenario, it is to be seen if the central bank revises its growth projection for the current financial year.

 
“High frequency indictors have not yet shown any significant slowdown in Covid cases, except some plateauing out of mobility report. Clarity on impact on growth of rising infections might emerge over the next three to four weeks,” said Sahay of Standard Chartered Bank.
 
In the February policy review, real gross domestic product (GDP) growth in 2021-22 was projected at 10.5 per cent – in the range of 26.2 to 8.3 per cent in the first half of the year and 6.0 per cent in the third quarter. The RBI had said rural demand was likely to remain resilient on good agriculture prospects, while urban demand and demand for contact-intensive services was expected to strengthen with a substantial fall in Covid-19 cases and expanding vaccination. The Covid-19 scenario has changed drastically since then, with rapid vaccination being the only hope for somewhat bringing the situation back in control.