RBI Policy: A Long Pause on the Anvil

As was widely expected, the RBI has left the key policy rate, the Repo rate, unchanged at 6.50%. The economic environment is very similar to the one in the month of April 2023, when RBI declared its first status quo policy in the current rate hike cycle.

Even though the inflation remains above the RBI’s target, it is within the tolerance band. In its fight against inflationary pressures the RBI raised the rates by 250 bps, the fruits of which are now visible by way of fall in inflation, but in the RBI’s own assessments “the fuller effects will be seen in the coming months”. The real positive rates and the projections that indicate limited risks to the same provide leeway to the RBI to adopt a wait and watch approach and be supportive of growth.

On Growth:

The RBI has projected real GDP growth of 6.5% for FY24. Despite the FY23 GDP growth surprising on the upside, the growth estimates for FY24 have been kept unchanged. The RBI sees domestic economy on a firm footing and states that, “healthy twin balance sheets of banks and corporates, supply chain normalisation and declining uncertainty, conditions are favourable for the capex cycle to gain momentum”. The risks to growth are expected to emanate from external factors and in this regard the policy mentions that “headwinds from weak external demand, volatility in global financial markets, protracted geopolitical tensions and intensity of El Nino impact, however, pose risks to the outlook.”

On Inflation:

For FY24 the CPI inflation has been projected to be 5.1% by the RBI. The inflation is expected to stay within the tolerance band but above the target for the entire year. The receding risks to near-term inflation and moderation in inflation expectations has been cited as one of the reasons that “provides the space to keep the policy rate unchanged in this meeting.” The RBI’s goal continues to be of achieving the 4% inflation target and thus policy mentions that even as a pause has been effected, the stance remains that of withdrawal of accommodation.

The status quo policy and the expectations of a long pause favour a fall in the market yields if money market conditions are normal. A logical readjustment of the yields would be moderation in short end yields, and a shift upwards of the long end of the curve. In either case the most suitable positioning for the debt portfolios is to be in the two-to-three year maturity profile, through products like Corporate Bond Funds, and Banking & PSU Debt Funds.

We expect RBI to maintain a longish pause unless there is a negative surprise on the inflation front. The current level of policy rates appears to offer an optimum trade-off between growth and inflation. Further rate hike in a real positive rate scenario may not be warranted. As aggressive rate hikes from here, to achieve the inflation target of 4%, may have a severe undesirable impact on domestic growth.

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