Hawkish tone maintained, rate cut in near future remains unlikely

Expert says interest rate cut in near future remains unlikely

The RBI Monetary Policy Committee (MPC) maintained the status quo with regard to rates by a unanimous vote on October 6 as the transmission of a 250 basis points increase in repo rate is still incomplete. Consequently, the standing deposit facility (SDF) rate will remain unchanged at 6.25 percent and the marginal standing facility (MSF) rate and the Bank Rate at 6.75 percent.

The MPC continued with the ‘withdrawal of accommodation’ stance (5:1 majority), as excess liquidity conditions have moderated with advance tax outflows in September and implementation of I-CRR (incremental cash reserve ratio) on September 8 (ends October 07) and the RBI may consider OMO-sales (open market operations) going forward to manage liquidity.

Inflation continued to remain the key focus area as the Governor emphasized repeatedly on bringing inflation down to 4 percent (versus the hitherto mentioned 2 percent-6 percent band).

The tone remained hawkish given the recent uptick in food prices, as seen from the increase in RBI’s inflation forecast for Q2FY24. CPI inflation edged higher to 6.8 percent in July 2023 and 7.4 percent in August 2023 largely driven by food price pressures. Lower sown area under pulses, onion production and demand-supply mismatch in spices as well as El Nino conditions could keep food inflation higher.

Near-term inflation is expected to soften on the back of vegetable price correction, especially in tomatoes, and the reduction in LPG prices. RBI maintained its CPI projection at 5.4 percent for FY24 while increasing it by 20bps to 6.4 percent for Q2FY24 and cutting the Q3FY24 forecast by 10bps to 5.6 percent.

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Deepak Jasani

Head of Retail Research|HDFC Securities

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Over the last one and half years, monetary policy actions broadly included compression of excess liquidity in the system, increase in policy repo rate by 250 basis points and change in policy stance to withdrawal of accommodation.

Complementing these measures were proactive supply-side interventions by the Government to improve the domestic availability of key food items and reduce input costs. A significant easing of inflation pressures from its exceptionally high level in July and August is expected to materialise in September as the impact of fleeting food price shocks wane.

High-frequency macro indicators (like credit growth, E-way bill, and kharif sowing) continue to comfort economic activity. Steady expansion has been seen in urban consumption while rural demand is showing signs of revival. The GDP growth momentum seems to be driven by the service sector and private consumption in the June quarter in spite of elevated interest rates. RBI maintained its real GDP growth projection at 6.5 percent for FY24.

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RBI has reiterated its inflation target at 4 percent and aims to align inflation to the target on a durable basis while supporting growth. The focus of the MPC has been on prioritising growth and giving demand stimulus during the ongoing festive season. Consequently, a rate cut in the near future remains unlikely.

10-year G-sec yields rose 12 bps to 7.33 percent due to the hawkish tone of the RBI and after it said they may consider Open Market Operations sales to manage liquidity (probably meaning “tighten” to bring down inflation).

Banks could see their NIMs coming under some mild pressure as rates remain higher for longer. Borrowers may not get any relief in interest rates in the near future. Liquidity conditions in the ensuing busy season may not improve. Equity markets (and especially bank stocks) though slightly disappointed with the policy outcome, have other triggers in the near term to track and worry about.

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