By Deepak Agrawal, CIO-Debt at Kotak Mahindra AMC
The Reserve Bank of India (RBI) announced the first monetary policy of FY25 on April 5, 2O24. The RBI’s Monetary Policy Committee (MPC) voted with 5-to-1 majority to keep the key policy repo rate unchanged at 6.50 percent for the seventh consecutive time. The six-member committee also kept the stance unchanged at “withdrawal of accommodation”. One of the MPC members, Professor Jayanth Varma voted to reduce the policy repo rate by 25 basis points (bps) and change in stance to neutral. The transmission of the cumulative 250 bps policy rate hike (since May 2022) into the economy is still underway as per the RBI.
The governor referred “CPI inflation” as the “elephant in the room” and also indicated confidence by stating that “the elephant has now gone out for a walk and appears to be returning to forest”. However, the governor in its commentary mentioned that even though the headline inflation has eased from its December peak, the pressure from food prices is holding back the ongoing disinflation process which is a barrier to achieving a target of 4 percent.
Also read: Strong growth momentum, bright outlook keep MPC focused on price stability
Also, the MPC left its inflation forecast unchanged at 4.5 percent assuming normal monsoon even though the country braces for extreme summer in the midst of rising crude oil prices and persisting worries about supply chain due to Red Sea crises.
The governor also highlighted that the public debt to GDP is raising concerns in many countries and this may impact future global financial system and mentioned that India is adhering to the path of fiscal consolidation. This means that the Indian economy is well posed for a non-inflationary growth ahead.
Additionally, the MPC observed that the domestic economic activity has illustrated durability, buoyed by robust investment demand and optimistic business and consumer sentiments. Additionally, RBI retained GDP growth forecast of 7 percent for FY25 with risks evenly balanced. This gives RBI a leeway to pursue rate cuts later.
Also read: RBI MPC: Experts list top 10 rate-sensitive stocks as RBI keeps repo unchanged
On the external front, INR remained one of the most stable currency. In the financial account, capital flows increased sharply in H2 of FY24 on account of foreign portfolio investment (FPI) extended the positive momentum in the same period, supported by net inflows in both net equity and debt segments.
Also, the RBI has managed liquidity very well and the weighted average call rate (WACR) was 21 bps above the policy repo rate in H1FY24 which has now eased to around 6.5 percent and is expected to stay in tandem with policy repo rate in future. We expect this to remain same going forward and will provide much desired comfort to the market.
The Federal Reserve is also likely to start cutting rates by the end of the second quarter (Q2-2024), with cumulative cuts of 0.75 percentage point or one point in 2024. Inflation has significantly declined from its peak in mid-2022 but it is still above the Fed’s 2 percent target level.
The bottomline is that the Indian economy is doing well, but inflation risks from food, fuel, and global shipping haven't disappeared. RBI Governor insisted that monetary policy must continue to be actively disinflationary to align to 4 percent target. RBI will be nimble footed and continue to use VRR (variable rate repo) and VRRR (variable rate reverse repo) based on evolving liquidity conditions.
Also, we expect a change in stance in Q2FY25 and 50 bps rate cuts in later part of FY25. Overall, it is a very balanced policy. RBI has shown comfort on long term rates and term spreads augurs well for duration play. We recommend investors to increase duration as much as they can in their portfolio.
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