Deepak Agrawal, Chief Investment Officer (Debt Fund) at Kotak Mahindra Asset Management Company
Since the outcome of the last Reserve Bank of India (RBI) policy in September 2022, the US Federal Reserve has hiked interest rates by 75 basis points (bps) and is likely to raise rates by an additional 50 bps in December 2022. The recent comments by US Federal Reserve Governor Jerome Powell were relatively less hawkish compared to the views expressed by other Fed governors, and the terminal rate expectation has been reduced from 5-5.25 percent to 4.75-5 percent.
In spite of the rate hike in the US in November 2022 and the incremental rate hike expected going ahead, the Dollar Index has fallen from 112 levels to 104.50 as on December 2, 2022. US 10-year yields have fallen from 3.8 percent level to 3.5 percent and the 2/10-year interest rate yield curve has further inverted from 40 bps to 80 bps.
The inverted interest rate yield curve suggests that the rate hike cycle in the US would be shallow. The USD-INR has also appreciated from the low of 83 per dollar seen in mid-October. The Financial Stability risk has also receded recently and the need for rate hike to manage the same has also reduced.
In a recent speech delivered by Michael Patra, Deputy governor of the Reserve Bank of India, on ‘The lighter side of Monetary Policy’, he explained the process of monetary policy making. “Monetary policy, by its nature, is a technical area of economic policy-making. Monetary policy has to be forward-looking because of the lags with which policy rate changes get transmitted across markets and is eventually reflected in lending rates, mortgage rates and yields. Hence, monetary policy can only hope to address the future rather than today’s inflation,” he said.
Patra further added, “At any point in time, the goal variables of inflation and growth are not necessarily visible to the monetary policy maker. Forecasts for the future are largely based on backward looking information of one to three months ago. Therefore, they can be thrown off course by unanticipated shocks that hit them in the future. In this challenging situation, monetary policy makers sift through an ocean of information (technical, economic, analytical and financial market indicators, etc.) as part of trying to guess the likely future path of the goal variables.”
Also read: Fitch retains India growth forecast at 7% for this fiscal, cuts projections for next 2 yrs
RBI has been largely accurate in forecasting growth and inflation estimates over the last few years, barring the current financial year (FY23). RBI had to write a letter to the government explaining the reasons for the breach of inflation target for three consecutive quarters. We believe, this should not result in RBI questioning its own estimates and they should continue to take monetary action based on its future estimates.
Real GDP for Q2FY23 increased by 6.3 percent in line with RBI estimates. Growth estimates for FY23 pegged at 7 percent, indicate second-half growth at 4.75-5 percent. Growth is likely to be lower in FY24. Market estimates for FY24 growth is in the band of 5.5-6 percent. RBI growth estimates are 50 bps higher than market estimates.
Since the last monetary policy, inflation has come in lower at 6.8 percent for the month of October 2022. The sequential momentum of the Wholesale Price Index (WPI) is falling consistently, which can benefit Consumer Price Index (CPI) with a lag. Inflation is likely to gradually trend lower and fall within the RBI’s target band by Q1FY24. RBI inflation estimate for Q4FY24 is pegged at 5.2 percent.
Also read: Low volatility and flexibility | Stocks that NPS-II chose to invest in. Do you own any?
In a recent interview, Dr Ashima Goyal, a member of the Monetary Policy Committee, had highlighted that a real rate of 100 bps is appropriate.
Liquidity has reduced in the system from April 22 till December 2022, and with deposit growth lagging in credit growth, it is also likely to exert pressure on lending rates, going forward.
Given RBI’s inflation estimates for Q4FY24, lower growth expectation for FY24, receding financial risk, and a cumulative spike of 300 bps in overnight rates since April 2022, we expect 35 bps hike in repo rate in the December 2022 MPC meet, taking the repo rate to 6.25 percent.
We also see merit in RBI changing its monetary policy stance from “withdrawal of accommodation” to “neutral”, suggesting future rate actions would be data-dependent.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Checkout Budget Highlights 2023
