RBI Policy Review: Moving towards a new equilibrium for yields?: Abheek Barua

Monetary Policy


The RBI kept the policy rate unchanged as expected and reiterated its accommodative stance both on the interest rate and more importantly liquidity. However, in our view, an accommodative stance does not imply the same level of systemic liquidity surplus and bond yields going forward.

www.newsbarons.comMarkets find themselves in a new environment of better growth prospects, increasing inflation risks (more demand side pressures), lower liquidity surplus and a significantly expansionary fiscal policy. These fundamental changes warrant a repricing of the yield curve towards a more “fair and consistent” band with the underlying economic metrics. We think this is likely to lead to the 10-year yield trading between 6.10-6.20% in H1 FY22. The 10-year yield rose sharply to 6.153% post the policy announcement from yesterday’s close of 6.07%. At the time of writing, the 10-year yield was trading at 6.106%.

“Yield curve is a public good”: While the RBI might continue to manage the yield curve through OMOs and Operation twists (perhaps more aggressive intervention incase the yield moves beyond 6.20-6.25% levels), it is unlikely to fixate on keeping the 10 year below 6% as it did in 2020. A realignment from both markets and the RBI on yields is only natural.

Today, the central bank also made a number of liquidity and regulatory changes. These included the extension in the HTM limit increase to 22% until June 2023, the announcement of retail participation in the bond market and the extension of the credit under TLTRO to NBFCs. The RBI also announced a phased roll back in the CRR cut from March 27 onwards. This is likely to open up space for the RBI to use yield management tools (plain vanilla OMOs) incase yields rise sharply in H1 FY22 once the governments’ borrowing program begins. To recall, the CRR cut had induced INR 1.37 lakh crore liquidity in the system last year.

Bottom line: The RBI is likely to continue with normalizing liquidity conditions in line with underlying growth and inflation fundamentals. However, they will make the process as non-disruptive as possible by continuing to keep liquidity in surplus. Yield management by the RBI is likely to continue, however the central bank is likely to be more comfortable with a higher band for yields than 2020.

The Specifics:

Inflation Outlook: While the RBI lowered its Q4 FY21 CPI estimate to 5.2% from 5.8% earlier, it revised up its H1 FY22 inflation estimates to 5.0-5.2% (from 4.6-5.2% earlier). For Q3 FY22 the RBI expected inflation to moderate yet again to 4.3%, with risks broadly balanced.

Supports: In today’s policy the RBI highlighted that the near-term inflation outlook has improved on account of bumper Kharif crops, rising prospects of a good rabi harvest, larger winter arrivals of key vegetables and softer poultry demand due to the spread of the bird flu. Risks: On the other hand, escalation in cost-push pressures in services and manufacturing prices and increased pass-through to output prices as demand conditions improve could impart upside pressures going forward.

Our View: We expect headline inflation to average 5.0% in Q4 FY21, slightly lower than the RBI’s forecast. That said, risks remain emanating from higher commodity prices, fuel prices and improvement in demand conditions and presence of pricing power in the system over the coming months. Further, an expansionary budget, hike in custom duties on certain mobile and auto parts and an introduction of agriculture infrastructure and development cess on items such as lentils, gold etc. could have a bearing on the headline inflation in the medium-term. We expect inflation to average between 5.0-5.5% in H1 FY22.

                            Inflation forecast

Monetary Policy

Growth Outlook: The RBI revised up its growth estimate for H1 FY22 in the range of 26.2% to 8.3% in H1FY22 (higher than the range of 21.9% to 6.5% projected earlier) and 6.0% in Q3. For FY22, the RBI expects growth at +10.5%, similar to our forecast of 10.0-10.5%.

On the growth front, the RBI expects the recovery in rural demand to remain resilient and urban demand to strengthen with the substantial all in COVID cases and the spread of vaccination.

Growth forecast

Monetary Policy

Key Regulatory Announcements:

Liquidity Measures:
•  Extension of TLTRO to NBFC through the on-tap route.
• Restoring the cash reserve ratio (CRR) in a phased manner. Banks would now be required to maintain the CRR at 3.5% of net demand and time liabilities (NDTL) effective from the reporting fortnight beginning 27th March 2021 and 4.0% of NDTL effective from 22nd May 2021.
• Extension of Marginal Standing Fund relaxation for a further period of 6 months – up to 30th
September 2021.

Regulatory Measures:

• The RBI announced to extend the dispensation of enhanced held to maturity (HTM) of 22% up to end of March 2023 to include securities acquired between April 2021 and March 2022. The HTM limits would be restored from 22% to 19.5% in a phased manner starting from the quarter ending June 2023.

Other Measures:

• To provide retail investors with online access to the government securities market – both primary and secondary – directly through the RBI. Retail investors can now open their gilt securities account with the RBI. Currently, retail investors can buy government securities through non-competitive bidding in primary auctions through intermediaries. The move is likely to broaden investor base and provide retail investors enhanced access to participate in the government securities market.

Liquidity eased to INR 5.1 trn in Jan 2021

Monetary Polict

Rising pressure on yields

Monetary Policy

Abheek Barua is Chief Economist at HDFC Bank.