RBI holds interest rates, with no hint of rate cuts

For the current financial year, 2023-24, the RBI’s estimate of growth is 7 percent while the government's estimate puts it at 7.3 percent. The RBI has pegged the GDP growth rate for the next financial year, 2024-25, too at 7 percent, while a Department of Economic Affairs paper ahead of the interim budget opted for a near-7 percent estimate with the potential to outpace this. This is significant. A conservative central bank projecting a better GDP growth rate and being more bullish than the government is good news for equity investors.

The inflation projection for the current year, 2023-24, was maintained at 5.4 percent. The important aspect, from the market’s perspective, is the inflation projection for next year. For 2024-25, Consumer Price Index-based inflation has been projected at 4.5 percent. This is benign. The point is whether this provides a case for interest rate cuts. The RBI’s target for CPI inflation is 4 percent. The upper tolerance band is 6 percent. The RBI’s view is that whenever there is an indication of inflation easing towards 4 percent on a sustained basis, there is a case for a change of stance from the prevailing “withdrawal of accommodation”.

The rationale for an interest rate cut is real positive interest rate. The repo rate, which is the pivotal rate to the RBI’s signalling of rates across the system, stands at 6.5 percent. To get a little technical, there is a metric of interbank call rate, which usually moves between the repo rate and the lower band of 6.25 percent. In recent times, the average call rate is moving around the upper band of 6.75 percent.

This is a result of liquidity tightness in the banking system, which tends to push up interest rates. Hence, if inflation averages 4.5 percent in 2024-25, the real interest rate is positive by at least 2 percentage points, taking the interest rate at 6.5 percent, or 6.75 percent. While GDP growth is buoyant, there should be a balance between inflation control (through higher interest rates) and promoting growth (through low interest rates).

Also read | RBI maintains status quo on rates. What should be your debt-fund strategy?

Positive signals, not-so-positive reactions

From an overall perspective, the RBI’s reading of the situation sounds good: buoyant GDP growth and benign inflation. This, in the language of economists, is called a Goldilocks situation, an ideal condition. However, the reaction of the equity and bond markets has not been as positive. The reason is that there was no hint of rate cuts or a softening of the stance.

A lower interest rate regime is positive for the equity market as corporates can avail of cheaper loans. For bonds, interest rates and prices move inversely, hence rates coming down is positive. As an individual, if you have availed of loans, you would prefer lower interest rates. Floating rate loans get reset quickly on changes in interest rates. For your investment portfolio, comprising equity, bonds, etc., today’s review does not call for any change.

The next review meeting is scheduled for April 5. Whether the MPC would change its stance from “withdrawal of accommodation” to neutral then is anybody’s guess. However, the possibility remains. At least we will watch out for any clues on interest rate reduction on that day.