Opening the stable doors: Update on RBI Monetary Policy, October 2024

Rate Action

The newly reconstituted Monetary Policy Committee, in its inaugural meeting, voted 5-1 to keep the policy repo rate unchanged at 6.5%. However, the Committee changed its stance to “neutral” from ‘withdrawal of accommodation’. The policy was dovish than market expectations. 

Forward Guidance

Market participants were approaching today’s policy with muted expectations. While high-frequency growth indicators (GST collections, exports, auto sales, core sector output) had seen softening, a backdrop of escalated geopolitical conflict in the Middle East and an increase in commodity prices due to expectations of Chinese stimulus had led to apprehension that the central bank may remain cautious and wait for a conducive environment to change its stance. 

In our opinion, the consensus stance change indicates an increased comfort amongst the RBI members on the future inflation trajectory given the above normal Monsoon and better prospects for food grain production. The RBI Governor also highlighted downside risks to the global growth outlook due to geopolitical conflicts and volatile financial conditions. 

Hence, the stance change affords RBI greater flexibility if inflation moves along on expected lines or growth surprises on the downside.

The MPC noted the following:

“The developments since the August meeting of the MPC indicate further progress towards realizing a durable disinflation towards the target. Despite the near-term upsides to inflation from food prices, the evolving domestic price situation signals moderation in headline inflation thereafter. The prevailing and expected inflation-growth balance have created congenial conditions for a change in monetary policy stance to neutral”. 

Below are key RBI estimates on the evolution of growth/inflation trajectory into the next year compared to their previous forecasts:

* Source: RBI, A- Actual

Assessment of Inflation

The RBI reduced its inflation forecast for Q2FY25 due to lower inflation prints for July and August 2024. The forecast for Q3FY25 was increased due to a transient spike in vegetable prices due to excess Monsoon. However, they have kept their annual inflation projection unchanged on the back of good kharif harvest, ample buffer stocks of cereals and a likely good crop in the ensuing rabi season. The RBI Governor noted adverse weather-related shocks and an escalation in the ongoing geopolitical conflicts as upside risks to the RBI’s inflation forecast.

Assessment of Growth

The RBI remained optimistic about growth for FY25, based on stronger agriculture, sustained private consumption and investment spending due to healthy balance sheets of banks and corporates, and the Government’s continued thrust on infrastructure spending.

Liquidity

We expect currency demand to pick up with the onset of the festive season. The ongoing financial market volatility due to geopolitical tensions may also lead to FX intervention and consequent volatility in liquidity. In the August 2024 MPC post-policy press conference, RBI Deputy Governor Dr. Michael Patra mentioned that liquidity is the “operating procedure” of its stance and not “independent in itself”.
(Source: https://rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1451)

Hence, we expect that the neutral stance will give greater flexibility for RBI to act in temporary periods of tighter liquidity to ensure money market stability. 

Outlook – A shallow rate cycle in a period of easy liquidity is constructive for a moderate duration

We believe the stance change, despite a volatile global macro backdrop, reflects RBI’s greater confidence in moderating inflation and implicit acknowledgment of softening domestic growth. The MPC by its December meeting should get further clarity on the expected food disinflation and economic activity.

We believe easing food inflation and moderation in growth compared to RBI’s projections should open space for 50-75 bps rate cuts in the current monetary cycle. Barring a commodity price shock, we expect the first rate cut to be initiated in December 2024.

Given the considerable gap between overnight rate and money market rates (up to 12 months), investors with a 6–12-month horizon can consider allocation to low duration/ money market strategies.

Investors with more than 12 months investment horizon can consider allocation towards moderate duration (one-to-four year) categories given the attractive accrual and prospects of mark-to-market gains on these strategies.

The views expressed are author’s own views and not necessarily those of UTI Asset Management Company Limited. The views are not an investment advice and investors should obtain their own independent advice before taking a decision to invest in any asset class or instruments

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