Status quo monetary policy, but focus on bringing inflation down to 4%

OMO sales, given that the Governor has ruled out any calendar for the same, would continue to remain a hanging sword over the markets and anchor any downward yield moves in the near term

Status quo on rates (repo at 6.5 percent, reverse repo at 6.25 percent and MSF at 6.75 percent) were maintained in the Reserve Bank of India’s (RBI) monetary policy on Friday. Votes remained unanimously in favour of no change in rates, however, we had a usual dissent on the stance by one member, Jayanth Varma. The phased extinction of incremental cash reserve ratio (ICRR) by October 7 was announced a month ago. The key message from the Governor’s statement has been the reiteration that the midpoint of 4 percent remains the policy target and not between 2 percent and 6 percent. This should enable an appropriate anchoring of market expectations surrounding the RBI’s stance, actions as well as overall inflation expectations. Liquidity management may remain the first line of defence as long as there is a directional trend towards CPI aligning closer to the midpoint of 4 percent.

Growth Concerns

The RBI’s growth expectation stays unchanged at a healthy 6.5 percent. We have our reservation on projections for the second half of FY24. Even as we acknowledge that India’s growth momentum is healthy, supported by domestic factors, we fear that technical factors (of skewed growth prints in 1H vs 2H of the fiscal) could lead to lower growth prints for 2H FY24.

The CPI inflation projections remain unchanged at 5.4 percent for FY24 and risks are fairly acknowledged. We have a similar print in mind though quarterly outcomes may vary. The fact that inflation projections stay above 5 percent for the next three quarters and the RBI has doubled down 4 percent target implies that rate cut expectations need to push out for a while and prospects of further adjustment in policy rates cannot be completely ignored. Commodity dynamics (both food and energy) are susceptible to heightened volatility in recent times. Unless we are through the weather and crude headwinds, monetary easing remains out of sight (to us).

Even as the RBI has announced the possibility of OMO sales in the coming months, we feel that the RBI would continue to assess factors such as currency leakage, foreign exchange flows to determine the same and the actions would be measured. However, OMO sales, given that the Governor has ruled out any calendar for the same, would continue to remain a hanging sword over the markets and anchor any downward yield moves in the near term.

Post the last phase of ICRR removal on October 7, the banking system will likely be sitting with a liquidity surplus of Rs 500 billion (Net liquidity adjustment facility) and durable liquidity (Net LAF+ central government cash balance with RBI) of ~Rs 3 trillion. We expect the surplus in durable liquidity to wipe out over the next six months given (a) the increased currency withdrawal by the public between October-April every year, and (b) our expectation of neutral to marginal deficit in net dollar inflow for 2H FY24 (which typically prompts RBI to sell dollars and absorb rupee liquidity). However, given the sharp weekly volatility in government cash balances (owing to skewness in tax collection and spending requirements), we could see a resultant volatility in liquidity absorbed or injected under the LAF window.

Worries About Personal Loans

The governor also opined some concerns about unsecured personal loans. India’s household net financial savings dropped to a near 50-year low of 5.1 percent of GDP by the end of FY23, led by a sharp jump in loans taken by Indian households. While there is broad-based growth in all categories of household loans, unsecured loans have grown significantly (23 percent CAGR between FY19 and FY23). With this, household debt to GDP has risen from 33-34 percent of GDP pre-COVID to 37.6 percent by FY23. This is at a historic high. Even though there are minimal signs of stress and no material concerns on personal loan default yet, such trends need more attention and the RBI is right to cast some caution.

The press conference elicited that of the Rs 3.62 trillion of Rs 2000 notes, Rs 3.43 trillion has returned to the system. Of this, 87 percent (i.e., ~3 trillion) has returned in the form of bank deposits. However, given that currency in circulation has fallen by only Rs 1.9 trillion from May 19, 2023 until Sep 2023 end (less than Rs 3 trillion of bank deposits), implies that public has withdrawn their bank deposits as cash from ATMs.

Overall, in India, from the macro perspective, higher crude, reduced domestic savings, the Centre’s increasing tilt towards social spending and external growth headwinds are emerging macro concerns but there are positives on continued domestic growth momentum, supply-side inflation management, continued positivity on service exports, additional sources of foreign capital.

We expect an extended pause in policy rates for now. The threat of OMO sales led to some sell-off in the bond market (as an initial reaction), which had been surprisingly very range-bound despite a significant rise in US yields. Elevated global bond yields, dollar, and crude along with no distinct visibility of the monetary easing cycle in the immediate future could cause some near-term pressure on domestic bond yields, though the impending dollar inflow in FY25 owing to bond index inclusion and good demand-supply balance for H2 could serve as a ceiling to Indian G-Sec yields.

Namrata Mittal is Chief Economist, SBI Mutual Fund. Views are personal, and do not represent the stand of this publication.