The Reserve Bank of India’s Monetary Policy Committee (MPC) expectedly chose to keep the repo rate unchanged at 6.50 percent, and a 5-1 on no change in the supposed stance of ‘focus on withdrawal of accommodation’.
The policy tone was confident on domestic dynamics and on meeting external financing needs, with growth upgrades and comfortable inflation trends despite near-term food-led risks. The RBI reiterated that policy must continue to be actively disinflationary to ensure fuller transmission and anchoring of inflation expectations and that past hikes so far are still working their way into the economy. But overall there was a sense of comfort in the policy tone, which was no surprise given that a benign global narrative, tighter domestic system liquidity and steady easing core inflation despite stronger growth acted as a comfortable backdrop for the December MPC meeting.
Fears of financial stability risks have taken a back seat amid swift changes in global risk appetite and low volatility in FX and other asset classes. This contrasts with the previous RBI meeting in October, when UST10Y was on its way to touching 5.0 percent and global commodity prices were moving higher.
Goodbye OMO sales, but active liquidity management remains a policy watch
We reckon that the policy prerogative was to ensure financial stability in the October meeting. The external dynamics were very different. We believe OMO sales were merely announced last time as a way to depict implied policy bias for higher rates and a way to offer higher risk premia to the world and to anchor INR – none of which turned out to be a worry. As we stand today, (1) a US Goldilocks scenario dominates the world narrative, UST yields have changed gears and while INR has stayed well-anchored; (2) the India-US 10Y spread has widened to ~300 bps after having seen the decadal lows of ~240bps in mid-October 2023, and (3) the average spread between weighted call money rate and repo rate has since widened to 20 bps (versus 2 bps average in September 2023. Going ahead, we expect liquidity to stay comfortable and range-bound in the near term but will likely tighten by March 2024.
Policy reversal to be a function of global dynamics
The swift change in global risk appetite is backed by higher market conviction of a wider runway for a soft landing and the Fed’s terminal state (a US Goldilocks scenario). The rates market now incorporates relatively high probabilities of easing by both the Fed and ECB, next quarter, led by better-than-expected recent inflation reports. This has probably led to the RBI mentioning for the first time the need to be mindful of the risk of overtightening – albeit on account of possible large global structural changes, and geopolitical and geo-economic shifts.
As market debates shift to timing/quantum of rate cuts ahead, the RBI’s mention of the “risk of overtightening” amid a fluid global backdrop strengthens our view that domestic policy reversal will be a function of global dynamics. We maintain that the RBI will not precede the Fed in any policy reversal in CY24 but policy management will have to stay vigilant and the policy tools will need diversification from conventional to unconventional ones.
(The writer is Lead Economist, Emkay Global Financial Services)
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