Will RBI policy move currency and bond markets?

MUMBAI: Financial markets including bonds and currencies, may not be betting big today as the Reserve Bank of India will declare its by-monthly credit policy next few hours with hardly anyone anticipating any surprise element. An ET poll among 15 market participants has clearly shown a “hold" on rates. But, will the policy be that boring?

Not necessarily!

A few illustrative words from RBI governor Raghuram Rajan could well trigger wild swings in the rupee-dollar exchange rate and bond yields.

A synopsis on what could move...?

RAJAN RAGA CAUSE: A statement from Rajan on his second term as his three-year term ends in September. Foreign portfolio investors may exit India in hoards if Rajan, who has earned credibility from them, leaves the post.
EFFECT: Any positive cue in this respect, could help bond yields to fall pushing prices up while the rupee should gain strength to the dollar.

INFLATION CAUSE: The food prices are rising while crude oil prices too are showing signs of upward trends. All add to inflation, a key factor for RBI cutting interest rates. So far, retail inflation is expected to be around 5% in FY17. Will RBI revise inflation forecast upwards?

EFFECT: If yes, that would be interpreted as a delay further rate cuts. Bond yields may rise pushing prices down.

STANCE CAUSE: RBI is now seen holding ‘accommodative’ stance, which eventually lead to interest rate easing. But, Is the central bank extending its stance or changing it? EFFECT: A hawkish stance can upset investor equations as many of them are betting on softer interest rate regime. This too may lead to rise in bond yields while overseas investors may get jittery.

FCNR (B) CAUSE: An element of fear is gripping investors on the back of foreign currency non-resident deposit schemes maturing in September-November. Fund outflows are estimated at $26 billion. Liquidity would shrink in the system.

EFFECT: This may pressurize the rupee against the dollar with the sudden outflows. If RBI resorts to open market operations by buying bonds from the market, that too would increase rupee liquidity in the system, which in turn, is again inflationary.

GLOBAL CAUSE: Global scene is uncertain with the fear of volatility looming large. Amid events like Brexit, US Federal Reserve Policy decisions, China slowdown and Japan fiscal contraction, the world is struggling to grow.

EFFECT: Domestic markets are not free from global shocks. RBI’s assessment is important especially when new statements/decisions will come up from both US Fed and Britain this month only.