FxWirePro: RBI surprises streets with reverse repo, more focus on inflationary outlook than INR appreciation – Futures of mid-month tenors to hedge

The Reserve Bank of India (RBI) surprised the market slightly yesterday by hiking the reverse repo rate and raising the inflation outlook slightly for FY2017-2018. The benchmark repo was left unchanged at 6.25%.

Although the reverse repo rate was increased by 25bp to 6%, this was more of an operation move rather than a signal of monetary tightening. It was a continuation of previous moves to narrow the monetary policy rate corridor, the difference between the benchmark repo rate (the rate charged to banks borrowing from RBI) and the reverse repo rate (the rate RBI pays banks for funds deposited with RBI). It is now at 25bp from 50bp previously.

RBI will continue to rely on open market operations (OMOs) and market stabilization scheme (MSS) to manage the liquidity situation. RBI maintained its neutral stance yesterday. At the margin, however, it could be viewed as sounding slightly more cautious over the inflation outlook.

It raised the inflation outlook for FY2017/2018 to 4.75% vs 4.5% in the previous statement in February.

On growth, it still sees it 7.4% for FY2017-2018 vs 6.7% in FY2016-2017.

We see RBI keen on anchoring inflationary expectations rather than signaling a hike anytime soon. As such, we no longer expect it to cut rates this year but to hold rates unchanged at 6.25%.

On INR, RBI did not comment much on the pace of INR appreciation of nearly 5% vs USD year-to-date (YTD). This suggests it may not be overly concerned about the valuation at this stage.

On a trade-weighted basis, we estimate it is around the same level as the 5-year average despite the strong appreciation YTD. Nevertheless, we expect RBI to mitigate further INR appreciation from here and we are likely to see some reversal of the seasonal factors that contributed to INR’s strength in Q1.

Well, having said that we wrap up with concluding note, long-term investors at current juncture contemplating above bearish indications, we advocate shorting futures contract of mid-month or near month expiries for arresting downward target towards 63.26 or even 61.12 levels cannot be ruled out upon breach of the 1st target.

Writers in a futures contract are expected to maintain margins in order to open and maintain a short futures position.