Once every two months, the Monetary Policy Committee (MPC) of the Reserve Bank of India meets to review interest rates and other aspects of policy related to the economy. Prior to a review meeting, the market builds in expectations on interest rate action, i.e., a hike or cut. Prior to today’s meeting, the expectation was that interest rates would be left unchanged.
Apart from interest rate per se, there is a stance or approach towards rate formulation. The stance from the MPC remains “withdrawal of accommodation”. There are three conventional approaches: hawkish, or a bias towards rate hikes, dovish, or a bias towards rate cuts, and neutral. The stance of “withdrawal of accommodation” is not usual; it stands somewhere between neutral and hawkish. There was a case for a change of stance to neutral as inflation has eased significantly. Real interest rates, given that inflation printed at 4.7 percent, repo rate being at 6.5 percent and 1-year Treasury bill yield being around 7 percent, are comfortably positive.
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However, the stance also was left unchanged. There was a mild downward revision in the inflation projection for the year. Inflation as measured by the Consumer Price Index for 2023-24 was projected at 5.2 percent in the previous policy review on April 6. On June 8, it was revised to 5.1 percent. The GDP growth projection for the year was maintained at 6.5 percent. If everything is status quo, what is the takeaway for investors and financial product consumers?
The way forward
Though the stance remains “withdrawal of accommodation”, i.e., interest rates may be hiked if required, for all practical purposes we may have seen the last rate hike of this rate change cycle on February 8, 2023. The reason why the RBI MPC is maintaining the approach is that their target for CPI inflation is 4 percent; the leeway of 2 percentage points gives an upper tolerance level of 6 percent. The CPI projection of the RBI is 5.1 percent for the financial year, and most economists are projecting even lower levels. Moreover, the interest rate is a balancing act between inflation control and promoting growth. Rates should be high enough to fight inflation but low enough not to hamper growth of the economy.
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Globally, the US Federal Reserve may go for at most another interest rate hike by 25 basis points, or may pause now. China and Japan are yet to hike interest rates. The European Central Bank is expected to hike rates once or twice more.
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The chatter in the market now is about interest rate cuts by the RBI going forward. It may happen, but the timing of rate cuts, and the extent, is anyone’s call. It all depends on inflation, global / Indian uncertainty, growth prospects and, finally, the RBI’s reading of the situation.
Impact
The markets, i.e., equity and bonds, are at similar levels as in the morning, prior to the policy decision announcement. Fundamentally, there being no palpable change in the interest rate policy of the RBI, it does not impact the markets in any major way. The non-reaction of the markets echoes that view. For equity investors, it will pan out as per the growth of the economy and corporate top-line / bottom-line. While interest rates are relevant for corporate bottom-lines, the fact is that the RBI repo rate has been hiked by 2.5 percentage points in this cycle. The effective rate hike is 2.9 percentage points, considering the hike in reverse repo rate in the initial phase of this cycle, from 3.35 percent to 3.75 percent. Bank lending rates have been hiked, and some more adjustment in marginal cost-based lending rates (MCLR) may be due. That is being absorbed by corporate revenue accounts, only that there is no fresh impact of today’s review.
For debt mutual fund investors, it is expected that yield levels will move in a range now, as there is no directional change signaled today. Funds will earn accrual-based returns, as per the yield level in the portfolios.
If you have taken a home loan, your EMI is not going up further. Though there is no change in stance to neutral, practically, rate hikes are over. For bank depositors, interest rates have moved up since the start of the current rate hike cycle since May 4, 2022. However, the extent of deposit rate hikes has been lower than the 2.5 or 2.9 percentage points hike executed by the RBI. Remarkably, a few banks cut their deposit and lending rates marginally in April / May 2023. But that is due to technical reasons—banking system liquidity is surplus. Rather, since credit demand is expected to remain buoyant, as and when banking system liquidity wanes, there may be marginal upward adjustment of deposit rates.
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