As per market expectations, the Monetary Policy Committee (MPC) reduced repo rate by 25bps to 5.15%, bringing the total reduction to 135 bps in 2019. The MPC sited continued global malaise, trade wars, sharp reduction in India GDP growth rate, benign oil prices and subdued inflation to continue with the accommodative policy. The MPC further noted that the output gap has widened further and inflation still remains within policy target and hence the committee is likely to continue with accommodative policy to support economic growth keeping inflation target in mind. The policy did not comment on fiscal slippage post corporate tax rate cut, but in the post-policy conference, the Governor opined that there was no reason to doubt government's fiscal aim.
Markets sold off post policy, as markets had already discounted a 25bps rate cut. Some market participants were expecting a steeper rate cut of 40 bps (post an unconventional 35bps cut in Aug'19 policy), but their hopes were belied. Further the Governor himself voted for 25bps rate cut. The market is well aware of fiscal risks emanating from steep corporate tax rate cuts and drop in GST tax collections. Despite the bonanza of Rs.1.72 lac crores in form of RBI dividend, the general consensus is of slippage of 0.5-0.7% in the fiscal deficit. While the government has not increased the borrowing amount for 2HFY2020, there is indication that they would review the situation in Dec'19. For that reason, the current borrowing calendar finishes in Jan'20, leaving Feb/Mar'20 for the extra borrowing required. This uncertainty is likely to keep markets on tender-hooks.
Inflation in 2nd half is also likely to creep towards 4% (on back of higher food prices as well as oil price volatility), which may pressure bond markets. With liquidity remaining in excess, hopes of open market purchases have further dwindled. We expect 10Y (new) to remain in range of 6.40-6.60% in near term with upward bias.