This policy, as anticipated, contained no significant unexpected components. The monetary policy stance of “withdrawal of accommodation” persisted, while policy rates remained unchanged. This policy was formulated against the backdrop of a declining inflation rate, namely vegetable prices. Additionally, the Governor stated that a positive aspect is that core inflation has been declining by 140 basis points since its zenith in January 2023.

In addition, the most recent survey of household inflation expectations indicates that expectations for inflation three months from now are down 90 basis points, while expectations for inflation one year from now are down 40 basis points. With demand recovering in the rural sector and remaining robust in the urban sector, the RBI characterizes growth as resilient. The overall development outlook for the year and FY25 remained unchanged at 6.5 percent.

Notwithstanding the aforementioned positive developments that have been emphasized regarding inflation dynamics, the RBI’s stance has not changed; its commentary and forthcoming guidance continue to be pessimistic. This can be attributed to the substantial levels of uncertainty that remain regarding inflation. Aspects of land sown with kharif pulses are deficient, kharif onion production requires close monitoring, and spice demand-supply mismatches are likely to persist. Significantly, the continuation and intensification of El Nino conditions are anticipated to exert an influence on worldwide food supplies and prices. September 2023 saw the FAO All Rice Price Index reach 141.7, a 0.5 percent month-over-month decline from August but a 27.8 percent increase compared to the index level at the same time last year.

I will attempt to situate the RBI’s monetary policy outlook within the global context in the following couple of paragraphs. A significant shift in the global rate environment has occurred. Commencing in 2003, the Fed Funds rate stood at 1 percent, a level not seen since the era of Alan Greenspan. The rates were subsequently grounded at zero percent in the United States during the tenure of Ben Bernanke and in the aftermath of the Great Recession of 2008.

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From that point forward until approximately June 2022, the US Fed Funds rate was, on average, lower than the CPI inflation rate. In contrast, the Fed Funds rate was nearly always higher than the prevailing rate of inflation between 1982 and 2002. To put it more simply, the United States economy had experienced prolonged periods of positive real interest rates prior to 2008. However, since the aftermath of the Global Financial Crisis (GFC), and continuing until very recently, the situation has been marked by negative real interest rates. This holds true regarding the ECB as well.

Currently, we are once again in the region of positive real interest rates. The most recent policy meeting of the US Federal Reserve outlined economic projections that continue to depict the economy’s resiliency. In accordance with the projections, the improved outlook also required the Fed to maintain a hawkish policy stance. Twelve members now anticipate a 25 basis point increase in interest rates by the US Federal Reserve in 2023, while seven others anticipate a hiatus. The dot plot now proposes a 50-bps reduction in interest rates for 2024, as opposed to the 100-bps reduction that was anticipated in the June projections. As a result, the message regarding “higher for longer” is unequivocal, and the Federal Reserve will maintain rates at restrictive levels for a longer duration than in prior cycles.

Significantly, the sanctity of the inflation target rate in monetary policy formulation is acquiring prominence on a global scale. The same holds true for India. As monetary policy communication becomes an increasingly significant instrument in managing and stabilizing inflation expectations, the Reserve Bank of India (RBI) reaffirms its commitment to attaining the 4 percent target consistently. The inflation forecasts published by the Reserve Bank of India (RBI) for the remainder of the year do not appear to indicate that the target of 4 percent cannot be met.

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In Q1FY25, the RBI anticipates headline CPI inflation of 5.2%. In addition, the RBI forecasts a CPI of 4.5 percent for the entire fiscal year of 2025, whereas YES Bank anticipates an average of 4.8 percent. Given the persistent evasion of the 4 percent handle, the Reserve Bank of India (RBI) faces significant challenges in even adopting a “neutral” monetary policy stance, let alone reducing the policy rate.

Thus, “higher for longer” continues to be applicable not only globally but also in the context of India. Additionally, it may prove challenging for the RBI to reduce interest rates prior to the US Federal Reserve, given that the interest differential between India and the US has shrunk to approximately 250 basis points, which is barely sufficient to offset the anticipated annual average depreciation of the INR. This interest disparity might continue to be significant for investors entering the Indian debt market, including those utilizing the JPM Bond Index inclusion route.

Bond market participants had not expected any modifications to the Reserve Bank of India’s liquidity strategy, particularly in light of the gradual reduction of the incremental cash reserve ratio (I-CRR). There were no additional measures specified in this policy. However, the RBI emphasizes once more that excessive liquidity can increase the hazards of inflation and financial instability.

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In doing so, the RBI reinstates the possibility of conducting open market operations (OMO) sales as a means of liquidity management. Although the likelihood of such OMOs being calendarized is low and would be contingent on changing liquidity conditions, the bond market has been alarmed nonetheless. As a result, the benchmark 10-year India G-sec yield has increased by approximately 12 basis points to 7.33 percent, and it may maintain its stability in the foreseeable future.

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CPI inflation increased to 4.8% in June 2023 from 4.3% in May 2023, but remained within the RBI’s acceptable range. The majority of the increase was attributable to a significant increase in food inflation, which rose to 4.6% from 3.3% a month earlier. Uneven monsoon and heatwave conditions have resulted in an abrupt increase in a few components of vegetable inflation. The sharp upward revision of near-term inflation projections (Q2FY24/Q3FY24 forecasts increased by 100bps/30bps to 6.2 percent/5.7 percent) is attributable to the food price risk. Although higher vegetable prices could pose an upward risk to CPI in the coming months, we believe this uptick is more transitory in nature and will subside in the second half of the fiscal year, per historical evidence. The RBI increased its CPI projection for FY24 from 5.1% to 5.4%.

After a delayed start, precipitation has increased; from a monsoon deficit in June to a 5 percent-above-average surplus in July. Recent IMD forecasts, however, indicate that August precipitation will be below normal (less than 94% of LPA). If the spatial distribution of rainfall remains asymmetrical, it could have a negative impact on kharif sowing and exacerbate food inflation in the future months. The recent increase in international crude oil prices as a result of supply decreases from OPEC+ countries could also increase imported inflation.

While food inflation is worrisome, the decline in WPI inflation is a source of solace. With a lag, the deflation of the WPI and the softening of the prices of many global commodities could provide some relief from the increasing inflationary pressures. Moreover, the moderation of core inflation provides additional solace. The core CPI fell to 5.1% in June of 23 and remains below the one-year average of 5.8%, reflecting the influence of past transmission on the real economy.

Studies have demonstrated that headline inflation follows the trend of core CPI, indicating that inflation dynamics are still under control. But the RBI is concerned about the impact on household inflationary expectations. In its statement, the MPC noted that these shocks are of a transient nature and can be disregarded for a period of time, unless there are repeated instances of food price shocks that pose a danger of anchoring inflation expectations. While the rainfall activity has acquired momentum, the temporal and spatial distribution of the same and a potential El Nio event would continue to be essential monitoring variables.

GST Collections, Corporate Tax Collections, and Income Tax Collections all indicate that India’s economic activity has remained resilient. Urban demand continues to be robust, with domestic air passenger traffic and household credit maintaining double-digit growth rates. The recovery of kharif sowing and rural incomes, as well as the buoyancy of services and consumer optimism, should boost household consumption. While high-end consumption and government capital expenditures are thriving, domestic demand and exports remain subdued.

The government’s emphasis on capital expenditure, higher capacity utilisation in the manufacturing sector, a moderation in commodity prices, and robust credit growth are growth stimulants. For FY24, the RBI has maintained its real GDP growth forecast at 6.5%. Significant hazards to GDP growth in FY24 include weaker global demand, geopolitical tensions, and the emergence of El Nino conditions.

Given the excess liquidity in the system, particularly as a result of the withdrawal of Rs 2000 notes, the RBI instructed scheduled banks to maintain an incremental CRR of 10 percent on the increase in their net demand and time liabilities (NDTL) between May 19, 2023 and July 28, 2023 in order to absorb the excess liquidity. As this announcement is negative for Banks in the short-term, the Bank Nifty fell following its release.

The impact of this announcement must be evaluated for each bank separately; the RBI will reconsider this decision by September 8 or earlier, based on the systemic liquidity levels preceding the holiday season. As the policy decision and commentary were essentially in line with expectations, the yield on India’s 10-year government bonds remained rangebound.

RBI is expected to keep a close eye on the inflation outlook and is intent on maintaining inflation expectations firmly rooted at its primary target of 4 percent, despite the difficulty of the task.

We believe that the central bank appears to be less concerned with growth than it is with inflation forecast uncertainty. In light of the recent rise in food prices, the likelihood of a rate cut increases. We anticipate a rate reduction in the first quarter of fiscal year 25 (Q1FY25), pending data.

Disclaimer: The opinions and investment advice expressed by investment experts on Moneypoise.com are not those of the website or its management. Prior to making investment decisions, Moneypoise.com encourages users to consult with certified professionals.

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A steep increase in the cost of staple foods like tomatoes, grains and pulses in July set the stage for the central bank to hike interest rates in August. The RBI is aware that these factors will cause the headline retail inflation rate to spike in the near future, thus they must be accounted for in the July inflation report.

There were no unexpected aspects of the policy, and the commentary was only somewhat hawkish, in contrast to market expectations. The RBI didn’t buckle under pressure and kept rates and its position of eliminating accommodation unchanged (with one member voting against). The Reserve Bank of India (RBI) made it abundantly plain in its statements that the temporary rise in retail inflation induced by the seasonal increase in the costs of select vegetables would be disregarded for the time being. Naturally, this is based on the expectation (and historical precedent) that the price of vegetables will drop significantly in the coming months. For the time being, this strategy may be appropriate.

A new analysis by the RBI reveals that although the seasonal supply crisis has caused annual peaks in tomato prices to be higher than the previous year, the floor has been nearly strongly maintained. Consequently, there is a possibility of a precipitous drop in tomato prices as the kharif crop arrives (around mid-August).

The Reserve Bank of India (RBI) will need to keep a close watch on the trend of inflation going forward and be alert to the threats to price stability. After the war between Russia and Ukraine (the “Covid crisis”), supply shocks drove up prices. Changes in the climate, the amplified effects of El Nio this year, and the continued asymmetry in the distribution of India’s southwest monsoons all threaten the stability of food prices.

Due to the difficulty in predicting the magnitude and duration of supply shocks, inflation forecasting has become a high-stakes endeavour. This brings the RBI’s annual inflation projection up to 5.4% from 5.2%. The RBI increased its average inflation projection for Q2FY23 by 100 basis points (from an initial estimate of 5.2 percent in June to 6.2 percent today, due to the recent shock in vegetable prices). Additionally, the projections for Q3FY23 improve by 30 bps to 5.7%. Curiously, the projection for the fiscal year’s last quarter is unchanged at 5.2 percent.

It’s safe to assume that a forward-thinking central bank would factor inflation expectations into policy decisions. The RBI’s inactivity was so comprehended. With an expected rate of inflation of 5.2% for the next calendar quarter (Q1FY23), a positive real interest rate of 130 basis points is implied by a currency policy rate of 6.5 percent. It’s starting to make sense now.

Still, the RBI would “go beyond Arjuna’s eye” and keep all possible instruments at the ready to bring inflation in line with the 4% target, thus the vigil on inflation will continue to take into account all relevant factors.

Inflation projections from YES Bank and the RBI are slightly different on a quarterly basis but remain very close on an annual one. No further rate hikes by the RBI are expected if inflation trends continue along these lines for the remainder of the year.

The possibility of a reduction in the policy repo rate by the RBI in FY24 has been the subject of recent speculation. As a result of the unexpected spike in prices, a reduction in interest rates is now unlikely before FY25. It is becoming clear that the US economy has shown surprising resilience to the huge and fast dose of interest rate rises in that country, effectively delaying the date of any Fed rate cut.

The RBI maintained the status quo on policy rates but warned of threats to price stability from an abundance of liquidity. The RBI’s attempts to sustainably drain out the surplus liquidity via the 14-day VRRR (variable rate reverse repo) have been hampered by the market’s lack of enthusiasm for this instrument. The Reserve Bank of India has mandated that, from May 19th to July 28th, banks keep a 10% CRR on their NDTL balances.

Based on our estimates, the banking system could feel a burden of almost Rs 1.1 trillion. The planned date for the measure’s repeal is September 8; this will prevent a sudden drying up of banking sector liquidity in preparation for the holiday season’s expected rise in C.I.C. The marginal cost of funds for the banking system will rise as a result of this action, but as the increase is expected to be short-lived, the banks may be ready to bear the cost themselves rather than pass it on to their consumers.

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In the short term, the recent increase in food and vegetable prices is cause for concern because it temporarily disrupts the downward trend in consumer price inflation (CPI) that the RBI has been able to achieve through monetary policy actions and liquidity management. The Monetary Policy Committee (MPC) has considerably (by 100 bps) increased its inflation forecast for Q2FY24 to 6.2%, which exceeds the upper limit of the RBI’s tolerance band of 6%.

The MPC has also increased its CPI projections by 30 basis points for Q3 and by 30 basis points for the complete fiscal year 2023-24. However, as anticipated, the MPC has decided to disregard the current spike in food inflation (caused by non-seasonal rains, El Nino, etc.) as it regards it as temporary.

Notable is, however, the RBI’s projection of an elevated CPI for Q1FY25 (i.e. April-June of the following fiscal year) at 5.2%. Given the continuous reiteration by the governor of the median CPI target of 4%, the most recent projections essentially eliminate any rate cut expectations for FY24. Unless there is a significant decline in global growth that has a considerable impact on domestic growth, it appears highly unlikely that the RBI will change course during the current fiscal year.

The introduction of the 10 percent incremental cash reserve ratio (referred to as I-CRR) on the net demand and time liabilities (NDTL) of banks during the recent May-July period was a bit of a surprise in this policy statement. The governor has acknowledged that the RBI’s Variable Rate Reverse Repo (VRRR) auctions are not having the desired effect on liquidity withdrawal, which remains in surplus mode, because banks prefer to store their excess liquidity in the SDF window rather than the VRRR window. The I-CRR measure is intended to be temporary (possible until September 8) and non-disruptive; however, it is likely to cause short-term increases in money market interest rates.

Overall, the RBI continues to emphasise maintaining a balance between containing inflation on the one hand and promoting growth on the other, while maintaining constrained liquidity. Due to the central bank’s emphasis on reducing liquidity, yield curves will remain level in the near future.

While the policy appears to be less hawkish than its predecessor, it moves back any expectations for rate cuts or even a softening of the policy stance (from the long-standing “withdrawal of accommodation”). In the coming months, domestic interest rates will remain elevated until there is clarity regarding a resumption of the downward trajectory of the headline CPI or meaningful moderating of growth conditions.

In the present environment, investors can capitalise on the high interest rate environment by investing in short- to medium-term fixed income opportunities, while the allocation to longer duration investments should be staggered with a longer investment horizon in mind.

The opinions and investment advice expressed by investment experts on Moneypoise.com are their own and do not reflect the views of the website or its management. Moneypoise.com advises users to consult with qualified professionals prior to making investment decisions.

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