Monetary Policy Review

The Reserve Bank of India left key policy rates unchanged in its bimonthly review of monetary policy. The committee voted 5-1 to keep the repo rate at 6%, with the lone dissent in favour of a rate cut.

Since November last year, inflation has remained below RBI’s target of 4%. Nevertheless RBI has been holding rates mostly steady until a rate cut in August. RBI’s key reason to hold rates steady has been that the drop in inflation this year has been on mostly transitory factors such as an unexpected drop in food prices; and therefore it is likely that in the months to come, inflation would once again rise above 4%. The current RBI forecast calls for inflation to reach 4.6% by the end of this financial year and remain close to 4.5% by end FY2019. This rise in inflation from current levels is expected to be driven by pay commission and GST effects.

While inflation has undershot previous expectations, so too has growth. The most recent GDP print of 5.7% for the June quarter was underpinned by a five year low in manufacturing growth of 1.2%. RBI follows a flexible inflation targeting framework. This suggests that with inflation close to target and weakening growth outlook, there is scope for monetary accommodation. However, RBI appears primarily guided by the risk of inflation remaining above its target than growth undershoot.

Complicating the equation is the risk of fiscal slippage. State government deficits have run high in recent years following the UDAY scheme for restructuring power sector debts. Now many states have announced farm loan waivers which may keep deficits high. The centre too has brought expenditure upfront this year to support growth that has taken the fiscal deficit for the first five months of the year to 96% of the full-year target. This means that there is the added risk of the centre not meeting its fiscal goals this year. The combined fiscal deficit (centre + states) has remained stubbornly above 6% for years now and any rise could result in inflationary pressures.

On the whole then, the RBI has indicated that it is maintaining a neutral stance to monetary policy – suggesting limited scope for rate cuts.

Benchmark 10-year G-Sec yields rose by about five basis points to 6.7%. The relatively small market reaction is indicative of the fact that the policy was largely on expected lines. Going forward it is likely that RBI will be on hold for a period of time and therefore it is likely that gilt yields too will be relatively range bound. It is interesting to note that despite much noise from macro indicators and the monetary policy committee, the 10-year yield has risen by just 20 bps since the start of the year.

Thanks to the excess liquidity introduced post-demonetisation, money yields are depressed and the call rate has been trading below the RBI repo rate. This has caused the yield curve to be the short end (up to 5 years) and relatively flat thereafter.  In the absence of a clear direction on rates, we do not see value in long bonds given the much higher duration risk. Consequently, we expect to maintain a low duration stance on our portfolios.

Investors with a medium term holding horizon should look to short and medium term funds, while those with a short-term holding period should consider liquid and ultra-short funds.


Sources of Data: RBI, Internal Analysis

This document represents the views of Axis Asset Management Co. Ltd. and must not be taken as the basis for an investment decision. Neither Axis Mutual Fund, Axis Mutual Fund Trustee Limited nor Axis Asset Management Company Limited, its Directors or associates shall be liable for any damages including lost revenue or lost profits that may arise from the use of the information contained herein. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The material is prepared for general communication and should not be treated as research report. The data used in this material is obtained by Axis AMC from the sources which it considers reliable. While utmost care has been exercised while preparing this document, Axis AMC does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Investors are requested to consult their financial, tax and other advisors before taking any investment decision(s). The AMC reserves the right to make modifications and alterations to this statement as may be required from time to time.

Axis Mutual Fund has been established as a Trust under the Indian Trusts Act, 1882, sponsored by Axis Bank Ltd. (liability restricted to Rs. 1 Lakh). Trustee: Axis Mutual Fund Trustee Ltd. Investment Manager: Axis Asset Management Co. Ltd. (the AMC) Risk Factors: Axis Bank Limited is not liable or responsible for any loss or shortfall resulting from the operation of the scheme.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.