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The Monetary Policy committee (MPC) presented its first monetary policy for the fiscal year on April 06, 2017. The MPC kept the policy repo rate unchanged at 6.25%, while maintaining the ‘neutral’ stance of the monetary policy, with all of the six members of the MPC unanimously voting in favor of the monetary policy decision. However, with a view to anchor the overnight call rate closer to the policy rate, the MPC increased the reverse repo rate by 25 bps to 6.0%, to narrow the policy rate corridor to 25bps from 50bps. While the markets were expecting RBI to announce measures to absorb liquidity from the system, the increase in reverse repo rate took the markets by surprise and resulted in yields rising by ~0.12% across maturities, with 10 year G-Sec yields rising by 0.12% to close at 6.77%.
Growth projection has been revised downward for FY17 to 6.7% from 6.9%, on account of short run disruptions in economic activity due to cash crunch and slump in demand due to adverse wealth effects due to demonetization. However, RBI expects growth to recover to 7.4% in FY18 on account of revival in discretionary demand held back by demonetization, transmission of rate reductions through MCLR reductions and Union Budget’s higher allocation for capex, rural economy and housing in FY18.
The MPC noted that CPI inflation is set to undershoot the target of 5% for Q4 FY17. However, the MPC has shifted focus towards bringing the headline CPI inflation closer to 4% on a durable basis. MPC took note of the potential inflationary pressures that may emerge from higher food inflation due to rising probability of a below normal monsoon, continued uptick in commodity prices, volatility in the financial markets on account of global financial market developments, 7th Pay Commission recommendations, high general government deficit exacerbated by farm loan waivers and one off effects of the GST. The MPC took comfort from the record production of food grains which would have downward pressure on food prices.
RBI also announced it could take many measures in order to revert the system liquidity to a position closer to neutrality, such as issuances of securities under Market Stabilization Scheme (MSS), purchase and sale of securities under Open Market Operations (OMO) etc.
We think that the interest rate easing cycle has broadly come to an end, as the yields have gone back to the pre demonetization levels. Hence we may not see a significant capital appreciation from the bonds, however, the upward movement in yields presents a good investment opportunity for earning higher regular income. The improving macro-economic scenario of the Indian economy presents good investment opportunity for Policyholders. Policyholders would be well placed to benefit from the economic revival if they continue to pay their premiums regularly and remain invested in the India growth story.
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