RBI Policy: Macros supportive of status quo continuance

Reserve Bank of India

The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) is scheduled to announce its decision on rates on June 7. It will be the second monetary policy of FY2025.

The benchmark repo rate is currently at 6.50 percent with a “withdrawal of accommodation” stance. The recently published GDP growth data for India for FY24 has reaffirmed that India is the fastest-growing major economy in the world, with a growth rate of 8.2 percent y-o-y in FY2024.

Headline consumer price index (CPI) inflation is trending lower, however, and remained above the RBI’s target of 4 percent.

GDP growth for the January-March quarter (the last quarter of the last fiscal year) had exhibited the same pattern as the previous quarter. The growth exceeded the market expectation at 7.8 percent, helped by lower subsidies, which caused Net Indirect Taxes (NIT) to surge 22 percent year-on-year GVA) a productivity metric) for the quarter, showing that construction and financial sector growth remained strong.

On the other hand, agriculture and manufacturing growth were a bit weaker. India’s PMI dropped to 57.5 in May from 58.8 in April. It is still above 50, which indicates economic expansion.

The RBI is closely watching the inflation trajectory as it remains a primary concern for the MPC. India's retail inflation eased marginally to hit an 11-month low of 4.83 percent on an annual basis in April as compared to 4.85 percent in the previous month. The number has remained within the Reserve Bank of India's (RBI) tolerance band of 2-6 per cent. However, in its past few commentaries, the RBI has maintained that its target is to get headline inflation below 4 percent on a durable basis. Inflation in the food basket grew to 8.7 percent in April, up from 8.52 percent in March, as per National Statistical Office (NSO) data.

On the liquidity front, the last two months have seen lots of volatility with banking system liquidity moving between a deficit and a surplus. This has resulted in erratic movement in overnight rates between the corridor's lower (6.25 percent) and higher range (6.75 percent). We expect the RBI to make some announcements around liquidity in the upcoming MPC.

The large government cash balance and continued borrowing without proportionate spending is aggravating the liquidity tightness. The government, on its part, also tried to manage liquidity with a reduction of the T-Bill auction calendar, announcing a buyback of government securities (though the acceptance rate remained low). While we await the full-year budget, spending may remain slow hence the Govt may reject auction bids at higher than market yields.

Inclusion in the JPMorgan emerging market debt index from June 2024 could bring in around $25 billion of passive inflows, according to market estimates. This will lead to increased liquidity in the market. Also, the Federal Reserve in the US has maintained the rate at 5.25 percent to 5.50 percent since its July 2023 meeting.

The Indian government is looking to reduce its fiscal deficit to 4.5 percent by March 2026, with a recent large dividend from the RBI reducing risk to government finances.

We recently saw India’s rating outlook changing to “positive” from “neutral” by the S&P although the sovereign credit rating has remained unchanged at BBB-. This indicates policy stability, increase in investment and long-term growth prospects. S&P hinted at a rating upgrade by mentioning that it will keep a check on government policies for the next two years by focusing on India’s fiscal deficit reduction target. A higher rating indicates the government’s ability to pay its debt and reduce borrowing costs, thus lowering the fiscal deficit. These factors indicate a higher growth rate, and do not indicate a rate cut by the RBI in the near future.

Looking at all the above factors—strong GDP growth, a likely managed fiscal deficit, inflation above the RBI target of 4 percent, and other major Global Central Banks yet to start the rate easing cycle—we believe that the RBI will maintain the status quo on rates as well as stance.

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