No rate action from RBI in the October monetary policy indicates that they would not want to use the interest rate tool to stem the currency depreciation. This is a bold contrarian call when compared to the various rate hikes by other EM central banks. However, by changing the policy stance to “calibrated tightening” RBI is also cautioning and preparing the market for a series of rate hikes in the current economic cycle.
The above can be termed as an announcement of “deferred rate hikes” by RBI. In the interim, the Foreign Institutional Investors may get anxious with the possibility of further depreciation of INR against USD and continue with their sale of INR bonds and equities. Also, at this time, the US economy is witnessing lowest unemployment in 50 years raising the threat of inflation shooting up beyond the target 2 percent level prompting Fed to hike rates more aggressively than earlier planned. The US 10 year treasuries have jumped up to a 7 year high of 3.22 percent. This combination is negative for EM bonds and equities.
We expect interest rates in India to stay elevated with the benchmark rate of 10 year GoI bonds in the range of 8 to 8.25% over the next few months. The credit spreads across the credit ratings will become higher for Indian Corporates and NBFCs. RBI is also expected to introduce tighter guidelines for NBFCs in order to restrict funding long term assets by short term borrowings. In this scenario, the advantage will continue to be with large private sector banks with strong retail liability franchises. Our equity portfolios are dominated with such banks which should help us weather the next few months of high volatility in the Indian markets.