The Monetary Policy Committee (MPC) kept the key rates unchanged (Repo rate: 6.5 percent, SDF: 6.25 percent, MSF rate: 6.75 percent) in a unanimous decision. All except Jayant Varma opted for the continuation of ‘withdrawal of accommodation’ stance. A pause-restart cycle in global monetary policymaking is the risk that has come to the forefront in recent weeks. In this context, the Reserve Bank of India (RBI) has rightly reemphasised the requirement to continue the withdrawal of liquidity and more importantly, stressed on the midpoint inflation target of 4 percent rather than take comfort from consumer price inflation (CPI) falling within the target band.
Growth Concerns
The FY24 growth projections were kept unchanged at 6.5 percent though there were minor shuffling in quarterly projections. Inflation was lowered marginally by 10bps to 5.1 percent (vs 5.2 percent estimate during April policy). The RBI seems rather cautious about its inflation forecast for the near term. In the first half of FY24, CPI could come 20-30bps lower than RBI’s estimates. However, given an evolving monsoon situation and volatile global commodity prices, RBI’s conservatism may be understandable here. Our annual inflation estimate is broadly aligned with the RBI (+/- 20/30 bps deviation in quarterly estimates). But we are more conservative on our outlook for India’s growth, particularly in the second half of FY24 when global growth slowdown gets pronounced. Our growth projections for the second half of FY24 are at least 100bps lower than RBI’s.
Liquidity has eased to comfortable levels in recent days. The return of the Rs 2,000-denominated notes into the banking system, and higher government spending, has led to liquidity swinging into a large surplus. The governor shared that about 50 percent of the Rs 3.6 trillion outstanding Rs 2000-denominated notes have returned, and 85 percent of that has remained as deposits for now, leading to Rs 1.5 trillion of additional liquidity in the banking system. The RBI promptly announced a series of variable rate reverse repo (VRRR) auctions over the last few days and sucked out Rs 1.5 trillion of liquidity.
India’s economy is much improved from a year ago. Growth is stable, and macroeconomic stability has improved with inflation, current account deficit, and the fiscal deficit, gradually falling. We believe that with unchanged rates and stance, the RBI remains rightfully cautious at a time El Nino could impact monsoon rains, and global inflation and growth conditions remain uncertain. We do not expect any change in India’s policy repo rate in 2023.
Long Pause Ahead
Historically a long pause is usually followed by a turn in the monetary cycle. Hence, odds are in favour of the next move to be a cut – though the quantum and timing could be debated. We think that RBI may be headed towards a long pause with a more serious discussion on easing at least six months away. The resilience in domestic growth could be a key variable that determines a potential change in the Repo rate downwards at any point in time. Conversely, a robust outcome on growth could provide more elbow room to eventually align CPI closer to the 4 percent target.
Even as the governor strictly maintains that MPC decisions are independent of monetary policy developments in the developed world, the renewed hawkishness in global central banks cannot be ignored. They find their way into the Indian macro via currency channel and limit RBI’s degree of freedom. Today’s developments and forecast changes simply reinforce our belief that the RBI will be on hold for the next few meetings.
Fixed income outlook in the Indian context, should be based on the thesis of “peak policy rates” rather than any anticipation of any immediate change in the monetary cycle. Shifts in liquidity dynamics, induced by policy choices/ actions may continue to remain the key variable for market yields trajectory soon. We are positive on duration from a year-long perspective as both global and domestic growth inflation mix dictates lower yields by the year end.
Namrata Mittal is Chief Economist, SBI MF. Views are personal, and do not represent the stand of this publication.
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