Expect 10-year G-sec to gradually drift higher from current levels

The RBI MPC decided to keep all benchmark rates unchanged – in line with our and market expectations. The bigger trigger was the introduction of a new tool – Standing Deposit Facility (SDF) at 3.75%, implying shift of 40 bps in overnight rates – which led to spike rates across the curve by 15-25 bps. 10 year G-sec benchmark has breached the 7% mark (last seen in 2019) to trade at 7.06% as I write this note (6.91% pre policy)


Key highlights of the policy

Repo rate unchanged at 4%. Stance remains accommodative. Reverse repo rate unchanged at 3.35% and MSF rate at 4.25%. Introduction of a new tool – Standing Deposit Facility (SDF) rate at 3.75% (which will now be the floor of LAF corridor instead of reverse repo rate). This window does not require g-sec as collateral.

All 6 members voted for keeping repo rate unchanged. All 6 members voted for retaining accommodative stance while focusing on withdrawal of accommodation to ensure inflation remains within the target going forward. Real GDP growth in FY2023 to be at 7.2% (earlier 7.8%).

Headline CPI inflation projected at 5.7% in FY2023 (earlier 4.5%). SLR holdings in HTM (Held to maturity) category limit has been enhanced to 23% of NDTL (net demand and time liabilities) and banks have been allowed to include securities acquired between April 1, 2022 and March 31, 2023 under the enhanced limit of 23%. HTM limits would be restored from 23% to 19.5% in a phased manner starting from the quarter ending June 30, 2023.


View & way forward

The policy has clearly shifted gear from being dovish to a more hawkish guidance and undertone. The accommodative stance is now geared towards being withdrawn to ensure inflation remains within target. This policy has clearly articulated its preference for sequencing inflation over growth as a priority in the current situation.

There is a reasonable chance that the policy stance may be changed from accommodative to neutral in the June policy – this is assuming current situation remains status quo.

The policy decisions are in line with our expectation on repo rate and stance. We have for long argued for a case to narrow the corridor between repo and reverse repos rate. With introduction of SDF, it will become the new floor at 3.75% even as reverse repo rate is at 3.35%. Thus, gap with repo rate stands reduces to 25 bps (from earlier 65 bps).

Liquidity normalisation process will be a gradual one (Currently ~INR 8.5 tn to a pre-Covid levels of ~INR 2tn). Thus, short end of the curve may stabilise after the initial inch up. The pace and quantum of repo rate hikes will be the next driver for short term rates. For now, we don’t see much aggression by the central banker on that front

Expect flattening of the yield curve to get more dominant as short end of the curve inches up more than the long end of the curve. The RBI remains non-committal on their plans to ensure orderly evolution of the yield curve (no OMO/OT etc on the radar for now) – not a very palatable situation given weekly supply and tepid demand. Expect 10 year g-sec to gradually drift higher from current levels, trying to play some catch up game with UST which has shown a relentless rise.

There may be some small relief for bonds as the HTM limit is increased to 23% till March 2023 even as the roadmap for phasing out begins from June 2023 onward – this is however a small sentimental impact and may get overshadowed given huge weekly supplies. Continue to focus on earning the carry on the fixed income yield curve. Floating rate instruments, state development loans to continue to retain appeal on relative basis

(The author is CIO – Debt & Head – Products, Kotak Mahindra Asset Management Company. Views are personal and do not reflect the views of Kotak Mahindra Asset Management Company Limited.)