Bond markets have no reason to cheer

BL Research Bureau

In his maiden policy review, the new Reserve Bank of India (RBI) Governor Shaktikanta Das spun a surprise and cut policy repo rate by 25 basis points.

Though there have been strong advocates of an easing monetary policy for long, the sudden largesse by the RBI has oddly not pleased the bond market much. The gingerly slip in the 10-year government bond yield by a measly 3 bps implies that the market has not taken too well to the RBI’s optimistic reading of inflation and fisc.

For instance, the RBI has cut its inflation projection sharply for the first half of 2019-20 from 3.8-4.2 per cent to 3.2-3.4 per cent. While low food inflation has dragged the overall consumer price index (CPI) inflation in recent months, whether such sharp fall in food prices will sustain remains to be seen. As the base effect wears out, food inflation could reverse, a possibility highlighted by the RBI, too.

Core inflation (excluding food and fuel) has also remained sticky. Of course, crude prices that have not upset the apple cart yet, is always the joker in the pack. Given all of these risks, the RBI reducing its inflation forecast drastically is not too convincing.

Above all, the fiscal expansion in the recent interim Budget 2019-20 has found a somewhat casual and dismissive reference in the RBI’s policy review, which is unsettling. The Centre’s big fiscal boost will likely have a significant impact on consumption demand, which, in turn, will fuel inflation. The bigger worry for bond markets is the whopping 24 per cent jump in gross market borrowing to ₹7.1 lakh crore in 2019-20. None of this seems to have been factored in by the RBI in its surprise rate-cut move.

Medium-term CPI picture

CPI inflation fell unexpectedly to a low of 2.19 per cent in December 2018. But core inflation has remained sticky over the past year; in December 2018, there was a sharp rise in health and education inflation, which may need watching in the coming months.

The RBI has itself projected CPI inflation for the third quarter of 2019-20 at 3.9 per cent, up from 3.4 per cent in the first half of the fiscal, indicating that inflation could move up.

Given that the RBI’s mandate is to steer the trajectory of inflation towards its target of 4 per cent over the medium term, the RBI could have waited for data trends before embarking on a rate-cut.

Fisc no worry?

For 2019-20, the Centre has pegged the gross market borrowing at ₹7.1 lakh crore. But aside from concerns over the Centre’s fiscal policy, several States announcing farm-debt waivers have ramifications for the fiscal burden of States. For FY19, as of January 25, 2019, the gross borrowing of States stands at ₹3.33 lakh crore.

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