RBI unlikely to change its policy stance in FY24
By Deepak Agrawal, CIO – Debt at Kotak Mutual Fund
The macro-economic pitch has improved from the last policy. Global yield lowers, GDP growth for FY24 now projected at 7 percent and CPI inflation for April-December 2024 projected at 4.63 percent. Some segments of the market were expecting the RBI to accelerate (change the stance to neutral), however RBI chose to play defensive and be in “wait and watch” mode, kept the rates unchanged and maintain the withdrawal of accommodation stance. We believe RBI will start accelerating (change the stance to neutral) from April 2024 policy.
The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) met amid strong growth in Indian economy reported in H1FY24. It was the fifth bi-monthly monetary policy of FY24 and decision was unanimous to keep the policy repo rate unchanged at 6.50 percent and majority of 5 out of 6 members voted to remain focused on “withdrawal of accommodation”. The monetary policy was broadly in line with the expectation. Since May 2022, there has been a cumulative rate hike of 250 basis points undertaken by the MPC, which is still working its way into the economy as per the RBI.
The MPC was positive on domestic growth outlook. According to RBI, though the global economy is showing signs of slowdown (unevenly across geographies and sectors), Indian economy remains resilient and has shown momentum. India’s real gross domestic product (GDP) growth surprised positively at 7.6 percent YoY in Q2FY24, exceeding all forecasts.
On the back of the turnaround in rural demand, increase in general government capex, healthier banks’ and corporates’ balance sheets, strengthening of manufacturing activity, high capacity utilisation, revival in private sector capex and other improving macro fundamentals, real GDP growth projection for FY24 was increased significantly from 6.5 percent to 7 percent, higher than the market expectation of ~6.7 percent.
Also read: Monetary Policy: RBI improves economic projections…how soon will rate cuts follow?
The RBI kept its FY24 consumer price index (CPI) inflation forecast unchanged at 5.4 percent. CPI inflation number for April-December 2024 is projected at 4.63 percent, broadly in line with the expectation. Though core inflation has been trending lower and CPI headline inflation has subsided over the last few months (falling below 5 percent in October), CPI inflation is expected to rise again in November and December, on account of uncertain food prices, especially intermittent vegetable price shocks and elevated global sugar prices. Thus, the MPC statement retained the need to stay highly alert around the inflationary trends, prepared to undertake policy action as required to ensure a durable alignment of inflation to the target rate of 4 percent, while supporting growth.
The RBI has been proactive in managing liquidity. It has stayed ahead of the curve with timely reduction in balance sheet size from 28.6 percent of GDP in FY21 to 23.3 percent in FY23 and further to 21.6 percent this year, up to December 1. The RBI remained focused on liquidity management in its statement.
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System liquidity turned to deficit mode in September after four years and deficit liquidity conditions persisted during October and November, tightening more significantly than envisaged in last policy. This prevented the need to conduct OMO-sales (open market operations sales) so far. With government spending expected to pick up, liquidity conditions may ease. At the same time, the RBI is cognizant of the risks of the over tightening and will remain nimble in liquidity management.
Real policy rates based on current overnight operating rate is close to ~2 percent, which is restrictive and hence made the case for change in the MPC stance to neutral. With global central banks yet to pivot and April-December 2024 growth projected at 6.5 percent, gives the flexibility to RBI to continue with the same stance.
We expect the Fed to pivot in 1st quarter of CY2024 only. Hence, we believe RBI will likely change the stance to neutral starting early FY2025 only.
The market reaction has been muted as the policy was broadly in line with expectation. The 10-year G-sec is expected to trade in the band of 7.15-7.30 percent in the near term.
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