RBI maintains calm against global noise

The Reserve Bank of India’s (RBI) bi-monthly monetary policy orchestrated on 8th August 2024 ensured that the “elephant” (headline inflation) was deep in the forest before changing the policy. The RBI’s Monetary Policy Committee (MPC) voted with 4:2 to keep the policy repo rate and stance unchanged at 6.50% and “withdrawal of accommodation” respectively. Like last policy, the two of the external MPC members, Prof. Jayanth Varma and Dr. Ashima Goyal voted to reduce the policy repo rate by 25 basis points (bps) and change in stance to “neutral”.

The RBI was cautious in its policy rate and stance as any hasty decision may jeopardise the good work done so far on inflation front. The June’24 headline inflation unveiled at 5.08% versus the 4.75% in its preceding month (May’24). Although, the headline inflation has fallen from its peak, the food inflation has remained persistently elevated and accounts for 46% of the CPI inflation basket. However, the RBI has kept the inflation forecast unchanged at 4.5% for FY25. Core inflation has remained low at 3.10% (June’24).The governor stated to not be complacent with low core inflation as the focus of MPC and mandate is for headline inflation. The Governor specified that there is some distance to cover to reach the 4% target as the inflation is moderating but is slow.

The real GDP growth forecast has remained unchanged at 7.2% for FY25. Domestic economic activity has been in uptick mode. The Purchasing Manager’s Index (PMI) for manufacturing has remained at 58.1 in July’24 and PMI for service sector remained at 60.3 in the same period and has remained above 60 for seven consecutive months indicating robust growth in service sector. The expansion in agricultural sector may improve the rural consumption. Additionally, the balance sheet of banks (CRAR and CET 1 ratio of scheduled commercial banks remained at 16.8% and 13.9% at March’24) and corporates have been strong. The recently announced union budget with push on capex, reduction in fiscal deficit target and signs of improvement in private consumption are barometers of strong growth economic growth conditions.

On the liquidity front, we observe that not much had been said by the governor. However, the system liquidity had been in deficit in June’24 and transitioned to Surplus in July’24. The weighted average call rate (WACR) has endured somewhere in the midway of LAF corridor. The yields on certificate of deposit (CDs) and 3-month T-Bill has fallen although the CPs have remained steady. The 10-year G-Sec yield averaged to 6.97 per cent during June’24 – August’24 (till August 6) in contrast to 7.08 per cent during April’24 – May’24. Moreover, the RBI has conducted several VRRR and over-the-counter open market sales of government bond to suck out excess liquidity from the system. The RBI will continue to be nimble and flexible in its liquidity management and aims in evolvement of money market in an orderly manner. Moreover, the country’s forex reserve reached all time high at $675 billion as on 2nd August’24.

The Indian economy has remained resilient despite global issues. The INR has remained range-bound and is the least volatile currency in emerging markets. In the recent time, we have seen markets in turmoil. The weaker unemployment data in US, increase in benchmark rate by Bank of Japan, dis-inverting of US yield curve (normalization for the first time in two years) with fall in two-year treasury yield, triggering of Sahm Rule recession indicator, escalating problems in Middle East are clear signs of “uncertainty” in global economies.

Given the backdrop, we find that RBI has remained prudent with its decision on policy rate and stance. The MPC is clearly focused on aligning headline inflation at its 4% target on a durable basis. The monsoon has been steady in the country and the likelihood of La Nina conditions is expected to have a positive impact on agriculture sector and consequently on food prices. Considering all the above factors, we expect a change in stance and easing in policy interest rate in H2 FY 2025. Further, supply (lower fiscal deficit in final union budget) and demand (FPI index flow plus draft LCR guidelines for Banks) dynamics remained in favour of G-sec rates drifting lower. Therefore, we recommend investors to increase duration in their portfolio as much as possible.

The author, Deepak Agrawal, CIO-Debt, Kotak Mahindra AMC.

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