Pitch is improving | RBI to play defensive as crude skids, rupee weakens, US yield eases

Next policy move expected to be a rate cut in CY24

The meeting of the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) began on December 6 to review the country’s monetary policy. The MPC’s decision will be announced on December 8. The MPC is expected to maintain a status quo on both the key rates and its stance when it shares the outcome of the meeting. The benchmark policy repo rate is currently 6.50 percent with stance of “withdrawal of accommodation”. The MPC kept the policy rates on hold for the fourth consecutive time in its last monetary policy meeting.

In latest released numbers, India’s GDP growth surprised positively at 7.6 percent YoY Q2FY24, beating the RBI’s projection by 110 bps for the quarter. It was backed by strong growth in manufacturing sector in Q2, making India the fastest growing large economy in the world. Also, since the last MPC meeting, consumer price index (CPI) inflation has eased to four-month low of 4.87 percent in October 2023 from 5.02 percent in September 2023 on the back of favourable base effect, vegetable price correction and the recent reduction in liquified petroleum gas (LPG) or cooking gas prices.

Though the CPI inflation stayed within the RBI’s tolerance range of 2-6 percent for the second consecutive month, it was above the RBI projection of 4 percent.

"We are not out of the woods yet and have miles to go, but readings of around 5 percent and 4.9 percent in September and October, respectively, are a welcome relief from the average of 6.7 percent in 2022-23 and 7.1 percent in July-August 2023,” a November 2023 RBI bulletin said.

The next two inflation readings (November and December 2023) could be close to 6 percent driven by higher food inflation, lower area sown under pulses, dip in reservoir levels, El Niño conditions and volatile global energy prices. Amongst all this, easing core inflation is a silver lining.

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Abhishek Bisen

Head - Fixed Income|Kotak Mahindra Asset Management Company

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Also read: RBI likely to opt for a prolonged pause until middle of next year

In October 2023, core inflation, which excludes volatile food and fuel prices, had fallen to around 4.2 percent, compared to 4.5 percent in September 2023. Even as RBI draws comfort from the moderation in core inflation, it would stay cautious as RBI's fundamental goal is to align CPI inflation with the 4 percent target on a durable basis.

Though crude oil prices have eased and have been trending lower, they have remained volatile. The point of caution for RBI would be weakening rupee as Indian rupee settled at an all-time closing low of 83.39 against the US dollar on December 5, 2023. The tightness persists in terms of overall liquidity and liquidity has remained primarily under deficit mode in last two months, with deficit exceeding ~Rs 1,00,000 lakh crore for few days. The RBI in its October 2023 policy announced that it may consider OMO-sales (open market operation sales) to manage liquidity depending on the evolving liquidity conditions. Given the deficit liquidity scenario, OMO-sales may not happen in near term.

Also read: Indian market more sensitive to growth, liquidity than valuation: Rashesh Shah

On global front, all three major central banks – US Federal Reserve, Bank of England and European Central Bank – have kept rates on hold/have left interest rates unchanged in their latest policy decisions, though have indicated that policy to stay tight for ‘extended period’. In latest numbers, Euro zone inflation eased to 2.4 percent in November 2023, from above 10 percent a year earlier, after 10 straight rate hikes, making the case of further rate hikes unlikely.

In US, markets are factoring in rate cuts faster than what central bank is predicting. There seems to be a contradiction in central bank and markets’ expectation the way long term US treasury yields have eased. This has put the RBI in a difficult situation making it complicated for the RBI to balance it all. Geopolitical tensions remain with ongoing Ukraine war and Israel-Hamas conflict.

On the above backdrop, we are expecting no change in policy rate and stance. The key thing to watch out for would be commentary/actions around inflation expectations and liquidity management. Though there’s a comfort from stable core inflation, RBI will remain cautious of impact of elevated food inflation on inflation expectations. We believe that the rate hike cycle has likely peaked out and the next policy move is expected to be a rate cut in CY24.

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