With neutral policy tone & liquidity management, rate cut unlikely any time soon

MPC maintains repo rate at 6.50%, with 5-1 vote. Consistent with 5-1 vote on unchanged 'withdrawal of accommodation' stance.

A benign global narrative, tighter liquidity, and easing core inflation despite stronger growth acted as the backdrop to this week’s Monetary Policy Committee (MPC) meeting. The policy tone was confident on domestic dynamics and meeting external financing needs, with growth upgrades and comfortable inflation trends despite near-term food-led risks. There was no change in the withdrawal of accommodation stance.

As market debates continue on the timing / quantum of global rate cuts, the Reserve Bank of India’s (RBI’s) mention of “markets running ahead of central banks” strengthens the view that domestic policy reversal will be a function of global narratives. While the RBI will stay vigilant on macro and financial stability, it is unlikely to precede the US Fed in any policy reversal in CY24.

Policy tone largely neutral

The MPC expectedly chose to keep the repo rate unchanged at 6.50%, albeit with a 5-1 vote split, matching the 5-1 vote on no change in the "withdrawal of accommodation" stance.

The RBI reiterated that policy must continue to be actively disinflationary to ensure fuller rate transmission and anchoring of inflation expectations, and said that past hikes are still working their way through the economy. It added that the last mile of disinflation is the trickiest to achieve, and to that extent, the current stance should be viewed in the context of incomplete transmission and inflation still being above 4%. Domestic dynamics are comfortable, with RBI expecting inflation to average 4.5%, even as they see growth linger around 7% in FY24-25.

The comfort in the policy tone was no surprise given the relatively tighter system liquidity (despite recent easing), and steadily easing core inflation despite stronger growth (see, “Three key questions ahead of the MPC meet”) .

Fears around financial stability have taken a back seat amid swift change in the global risk appetite and low volatility in FX and other asset classes. Today’s policy again stressed on improved domestic and external macro dynamics, and healthy balance sheets of banking and non-banking financial institutions, while insisting on remaining vigilant. The outcome of the MPC meet is mostly neutral for bonds.

Not perturbed by system liquidity

The stance has been loosely linked to liquidity management as well, as it is endogenous to the policy rate. System liquidity has tightened since Sep 2023, and significantly worsened since mid-Dec 2023 (above 1% of NDTL), with the Jan 2024 deficit averaging Rs 2.1 trillion, led by higher government cash surplus (averaging Rs 3.7 trillion since Oct 2023) and higher CIC (currency in circulation), among other factors.

The RBI has argued that the financial market has adjusted to the evolving liquidity conditions in varying degrees, and that adjusted for the government surplus, durable liquidity is in surplus. They also added that a formal change in stance should be viewed in the context of broader policy aims.

A change in stance can wait

Given that the call money rate has been hugging the MSF for the last four months (barring the past few days), technically, the accommodative stance is already under the scanner. However, the recent week has seen the liquidity deficit easing to sub-Rs 1.5 trillion, and the RBI is now holding VRRRs (variable rate reverse repo) auctions to keep overnight rates above the repo rate — reflecting their preference for flexibility in liquidity management through two-way fine-tuning operations. The MPC also said that it may deploy an appropriate mix of tools to modulate both frictional and durable liquidity to keep the money market well balanced.

Understandably, the RBI would be biased towards keeping overnight rates more aligned towards the repo rate than the MSF / SDF (marginal standing facility / standing deposit facility) rate. A part of this would be naturally achieved as estimates suggest system liquidity deficit is likely to ease to 0.5-0.8% of NDTL (net demand and time liabilities) in the coming months, vs 1.1-1.2% of NDTL in Jan 2024.

A stance change, thus, may come only beyond April 2024, and will give the RBI some elbow room to understand and adjust to fluid global dynamics, and there does not seem to be a need to do any CRR (credit reserve ratio) cut or OMOs (open market operations) for near-term liquidity fine-tuning.

Policy reversal to be a function of global dynamics

The change in global risk appetite is backed by the market’s conviction of a longer runway for a soft landing, and a Goldilocks scenario in the US. The RBI's policy has been somewhat pegged to the Fed, specifically in the last two years, even as it formally targeted inflation. However, shifting global narratives requires the RBI to be flexible as well. At present, a change in risk appetite and low volatility in risk assets has given comfortable breathing space to emerging markets, including India, on offering higher risk premia.

As of now, markets are assigning ~60% probability of the first Fed cut by May 2024 (total 117 bps cut in CY 2024); and domestically, with one cut each in Jun’24 and Oct’24 (sorry, not clear). We think factors such as: 1) US inflation trends taking time to be discerned; 2) economic resilience; and 3) easier financial conditions feeding back into demand may be slowing any early move towards easing by any key DM (developed market) central bank this year. This should restrain the RBI from cutting rates early as well – something they also alluded to this week.

As of now, we do not see the Fed cutting rates before Jun 2024, with the RBI following suit with a lag.

The author is the Lead Economist at Emkay Global Services.