By:- Suyash Choudhary, CIO – Fixed Income, Bandhan AMC
There are 3 sets of ongoing global and local themes that, in our view, bear very close watching:
1.Broad based upward pressure on global commodity prices: While the recent escalation in energy prices on the back of dialling up in Middle East tensions is watched the most closely, there is now a broad-based pressure across commodities, notably agricultural ones as well. As the chart below shows, a more generalised commodity index is back up to March – April highs. This was when oil was much higher than it is now.
As far as the Indian context is concerned, monsoons are uneven, GDP growth has been strong, and credit is growing at around 18%. Thus conditions, both global and local, point to rising inflationary pressures, even as the data up to now has been a source of comfort for RBI. While up-till recently we had also drawn comfort from MPC’s focus on core inflation, we no longer think this should be relied on going forward. Indeed, the perceived greater hawkishness of the last policy minutes does highlight the rising watchfulness of MPC members. With global price pressures getting worse since then, we would assume members will be getting even less comfortable with the current policy positioning.
2.More debate on global neutral real rate policy setting: The rise of AI build out increasingly has multiple repercussions. It has a dominant contribution to the private capex cycle in geographies where the build out is happening. Growth rates have been lifted, and worries have resurfaced whether policy rates are currently restrictive enough to support incremental disinflation. This is especially so in the US where the AI build out is large and inflation has been higher than target for the past 5 plus years. More generally, however, rate hikes are back on the table in many other major geographies as well. Besides, debt raising for financing AI building is leading to increase in bond supply and thereby putting additional pressure on bond markets. While India is not experiencing a similarly intense private capex cycle, the general global rate dynamics matter for us as well. Thus, local financial conditions are not immune from the global setting over the medium term, as the last few quarters have adequately shown.
3.India’s monetary policy setting has incrementally loosened: The observations above argue for a more normalised monetary policy setting in India. Instead, we have headed the other way courtesy recent developments. FCNR flow has risen to USD 127 billion and total at USD 136 billion. While a definitive show of strength for us, this has also complicated RBI’s liquidity management. We estimate current core liquidity will be circa 4% of banks’ net demand and time liabilities. Even though RBI is trying to mop up the excess via short term VRRRs, this is not fully effective. Further, collateralized overnight rates have slid to the 4 – 4.5% area and short-term money market instruments are being dragged to sub 6% yields. Urgent attention is required with substantial measures, for overnight rates to sustainably re-anchor to the policy rate as a first step. Furthermore, in our estimate core liquidity will still likely be more than 2% of NDTL as at March end. Thus, RBI may have to deploy a combination of temporary and more permanent measures for liquidity absorption, and sooner rather than later.
