By Azeem Ahmad, Senior Director, Discretionary Investment Services, Waterfield Advisors
As was widely anticipated, the Reserve Bank of India (RBI) has chosen to maintain the status quo on policy rates, attributing its decision to an unstable global macroeconomic environment despite robust domestic macroeconomic conditions.
In a move that echoes his sentiments from the April meeting, RBI Governor Shaktikanta Das reiterated his emphasis on the bank's reaction function in response to the evolving global situation and the domestic growth-inflation scenario, maintaining the flexibility of the bank's policy.
This continuity in the RBI's stance since the April meeting enhances its credibility, a luxury which not many central banks in developed markets can claim to have these days.
Developed Markets Analysis
Persistent core inflation and a robust labour market suggest a pause, not an end, to rate hikes. The governor also debunked the market theory suggesting a correlation between policy pauses and terminal rates. Inflation, particularly core inflation in key developed markets, continues to exceed the comfort levels of most central banks in these regions, undermining the notion of a causal relationship between a pause and the terminal rate.
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Major developed markets such as the US, UK, EU, and Japan, where core inflation continues to rise, are also witnessing a sturdy labour market, showing no signs of significant slowdown. This scenario has prompted numerous central banks in developed markets to increase rates further, the most recent ones being the Reserve Bank of Australia and the Bank of Canada. As of now, the US futures market is pricing in a 65 percent likelihood of a rate hike by the Federal Reserve in July, up from ~40 percent for June 15.
Asian Emerging Markets (excluding India) Analysis
These markets present a less daunting scenario compared to their developed counterparts, thanks to appropriate monetary activism. This week, the Reserve Bank of Australia and the Bank of Canada caught investors off guard with rate hikes, which have influenced traders' expectations for the Federal Reserve. However, the situation in some parts of emerging Asia stands in contrast.
Although the Bank of Thailand has indicated a hawkish stance, May's headline inflation fell below the central bank's target range of 1 percent-3 percent. Bank Indonesia has consistently maintained its peak rate stance, as May's inflation also remained within the target band. On the other hand, the RBI reported that April's headline inflation rose by 4.70 percent, which falls within the 2 percent-6 percent desired range, albeit it is expected to stay above 4 percent for FY23.
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Of note, the widening rate differential between the Federal Reserve and regional policy rates has yet to exert significant additional pressure on Asian currencies, relieving policymakers of the need for immediate rate hikes. However, due to the challenging macroeconomic environment, characterized by stubborn inflation in developed markets and smaller policy rate spreads between developed and emerging markets, Governor Das's decision to uphold policy flexibility was a prudent one.
India Analysis
Macroeconomic indicators stay robust, but the unpredictability of El Nino remains a significant concern. While the recent broad-based reduction in inflation is encouraging, the potential impact of El Nino on monsoon patterns leaves room for inflation risks. Consequently, the inflation forecast was slightly adjusted downwards by 10bps to 5.1 percent.
However, in light of strong domestic indicators like the Manufacturing Purchasing Managers' Index (PMI) and healthy Goods and Services Tax (GST) collections, the RBI has kept its growth forecast for FY24 at 6.5 percent, with an upward revision for the first half of the fiscal year.
The RBI has adopted a cautious yet responsive approach to liquidity, which is currently in surplus due in part to the 2000-rupee notes. The bank intends to continue its stance of liquidity withdrawal, a decision supported by five out of six members.
Overall Conclusion
The fixed income and foreign exchange (FX) markets have consistently exhibited a trend that started in March 2020, with both interest rates and the value of currencies increasing. A breakout from the narrow range that has been observed in these markets could occur if the US dollar gains strength and/or if the forward rate pricing increases in major developed markets. This suggests a potential risk of market weakness, particularly in the event of a global downturn.
On the whole, the Monetary Policy Committee (MPC) has managed to uphold its credibility through carefully balanced and consistent policy decisions. By keeping its options open, the MPC has been able to navigate the shifting global macroeconomic situation and maintain a focus on strong domestic economic indicators. This has been achieved despite the rising liquidity in the system and inflation concerns driven by potential risks to the upcoming monsoon season. As a result, the prospect of a rate cut in the current fiscal year appears increasingly unlikely.
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