The RBI decided to maintain status quo on the rates front and continue with its stance of withdrawal of accommodation to progressively achieve its inflation target of 4%, while supporting growth. While there were no expectations on the rate front, there were some market participants expecting a change in stance from the current one of “withdrawal of accommodation”. These expectations were firstly based on tight systemic liquidity conditions and secondly on hopes that RBI might prepare the ground for a turn in interest rate cycle over the next financial year.
The RBI it seems took cognisance of the market expectations, providing update on both liquidity and the interpretation of the policy stance. The points, in this context, mentioned in the governor’s address are as follows:
Adjusted for government cash balances, potential liquidity in the banking system is still in surplus. The pick-up in government spending augmented the system level liquidity.
Our stance of withdrawal of accommodation should be seen in the context of incomplete transmission and inflation ruling above the target of 4 per cent and our efforts to bring it back to the target on a durable basis.
On Growth:
The RBI expressed its confidence in the growth trajectory of the domestic economy. The momentum gained in FY24 is expected to continue in the next financial year as well. All the major segments of the domestic economy such as agriculture & allied activities, construction, government capex, private capex and services sector are indicated to be healthy contributors to domestic growth. The risks to growth are largely seen to be emanating from the external sector. The key risks cited by RBI are the ongoing & developing geopolitical concerns and the elevated level of public debt globally giving rise to serious concerns on macroeconomic stability. In line with the improved outlook on domestic economy the growth forecasts have been modified higher. The GDP growth expectations for FY24 have been raised to 7.3% from 7%; for FY25 GDP has been projected to growth at 7%, the quarterly projections have been revised higher by 30 to 60 bps.
On Inflation:
The effect of RBI’s monetary policy actions is visible in core inflation (CPI inflation excluding food and fuel). The core inflation softened to a four year low of 3.8% in December 2023. Notwithstanding the risks to supply channels due to geopolitical risks, the global growth outlook and the continuous pass through of monetary policy actions is expected to keep the core inflation muted.
In RBI’s words, “Going forward, the inflation trajectory would be shaped by the evolving food inflation outlook”. The food inflation has been a major factor that is keeping the headline numbers outside the RBI’s targeted range. The upside risks and the possibility of “generalisation of food price pressures to non-food prices” are the factors that have shaped the decisions of this MPC meet. The key statements, in this context, in the policy announcement are, “Monetary policy must continue to be actively disinflationary to ensure anchoring of inflation expectations and fuller transmission. The MPC will remain resolute in its commitment to aligning inflation to the target”.
Outlook:
Inflation has already led to some kind of slump in demand in the rural economy. Revival is expected due to summer season and elections related spending. This revival and sustaining the critical investment cycle is dependent on a rate cut and easing liquidity. Though headline is above the target, and it is affected by seasonality, it may not pose an insurmountable impediment for the policy makers. Given that domestic economic growth is robust and expected to maintain the momentum, the RBI has some space available to get the headline numbers within the targeted range.
Investment Preferences:
• Market yields are south bound with or without rate cut.
• The borrowing program of the government is much lower, tax buoyancy both in direct and indirect taxes is quite evident and we have already received FPI inflows to the tune of US$7.50 billion in bond market in the last three months.
• These inflows may touch US$ 20-30 billion in the coming year. It could be even double of this amount. This will supply liquidity in the local market and push down yields to lower levels.
• Investors may consider adding duration to their fixed income portfolios through Gilt Funds.
• The yield for the 10-year benchmark is currently at 7.08% levels, and as per our initial analysis the first target is 6.8% – 6.9%. The yields for Git Funds is in the range of 7.3% to 7.5%.
