RBI MPC (Monetary Policy Committee) is set to for their first Bi-monthly meeting for fiscal 2017-18 on the 5th and 6th of April. The market widely expects RBI to maintain rates status quo in its policy and stay with the neutral policy stance.
RBI could however send warning signs on inflation, making the policy hawkish. CPI inflation forecast of around 5% for 2017 is likely to be maintained but upside risks can increase. The factors that can take inflation higher would be lower than normal monsoons, GST introduction in July and high liquidity from both demonetization after effects and from strong FII flows.
The monsoons this year are expected to be below normal on the back of El Nino weather conditions. Weak monsoons increase prospects of higher food prices and this could lead to rising food inflation. GST rates could raise prices of many goods and services in the economy and that could push up inflation in the short term. Demonetization has left residual surplus liquidity of around Rs 5000 billion in the system while FII’s flows have surged in the last two months on the back of political stability and higher economic growth expectations in India. High liquidity can lead to inflation if it results in consumer demand rising on the back of cheaper funds.
Yield curve spreads have risen sharply on market fears of inflation and that would largely protect bond yields from rising even if RBI sounds more hawkish than usual. However with government bond auctions hitting the market in April, bond yields could be pressured till markets feel comfortable on rates.
The ten year benchmark bond, the 6.97% 2026 bond saw yields fall by 13bps week on week to close at levels of 6.69%. Financial year end buying by banks to shore investment profits took the yield down. The old ten year benchmark bond, the 7.59% 2026 bond saw yields fall by 13bps to close at 6.85% levels while the 7.88% 2030 bond saw yields fall by 2bps to close at 7.33%. The 8.13% 2045 bond saw yields fall by 11bps to close at 7.45%. Bond yields will rise this week as markets worry about RBI tone in its policy this week.
OIS market saw one year OIS yield and five year OIS yield rise by 1bps each. One year OIS yield closed at 6.41% while five year OIS yield closed at 6.64%. OIS yields are likely to rise on RBI policy.
10 year benchmark AAA bond yields closed lower by 13bps at 7.60% levels with spreads flat at 79bps Benchmark 3 year AAA corporate bond yields closed 12bps down week on week at 7.31% levels. Credit spreads fell by 11 bps to close at 64bps levels. 5 year benchmark AAA bond yields closed down by 6bps at 7.47% with spreads up by 9bps at 74ps levels. Credit spreads will stay down given stickiness of yields at higher levels.
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) and MSS bond issuance was in surplus of Rs 2524 billion as of 31st March 2017. The surplus was Rs 4070 billion in the week previous to last. There were no MSS bonds outstanding. Rise in currency in circulation on RBI easing limits on cash withdrawals and year end shoring up of funds by banks led to drop in liquidity. Liquidity will be back into the system this week.