Something for the pain: Update on RBI Monetary Policy, December 2024

Rate Action

The Monetary Policy Committee voted 4-2 (on December 6, 2024) to keep the policy repo rate unchanged at 6.5%.

External members, Dr. Nagesh Kumar and Prof. Ram Singh, voted for a 25 bps cut. The 4-2 voting pattern compared to 5-1 in the previous policy reflects the increasing difference amongst the committee members of the growth-inflation dynamics. All six members voted to maintain the stance at “neutral”. The policy was largely in line with market expectations.

Assessment of Policy Action

Economic and geo-political considerations have meaningfully changed since the October ’24 policy. The most notable considerations before the Central Bank ahead of today’s policy were:

1) Higher inflation: An increase in food prices led to the Oct’24 CPI inflation print meaningfully overshooting RBI’s October forecast. While the high food prices are expected to normalise in the near term but nonetheless, they will lead to an upward revision in RBI’s annual estimate. Today, RBI revised its FY25 inflation forecast to 4.8% from 4.5%.  
2) Increased geo-political risks: The strong political mandate to the new US administration and consequent ramifications on global trade have the potential to increase FX and rate volatility.  Market expectations of the Fed rate cycle are also tempered with participants expecting 50bps lesser cuts by the Federal Reserve compared to the Oct’24 policy. This has resulted in meaningful FPI outflows, with domestic FX reserves declining to $656Bn from $701Bn in October (Source: Bloomberg).  
3) Downside risks to growth: Q2 FY25GDP growth came at 5.4% against RBI’s estimate of 7%. Moreover, high-frequency indicators (tax collection, auto sales, etc.) are pointing towards softer growth ahead. 

The RBI Governor noted the following:

“Since the last policy, inflation has been on the upside, while there has been a moderation in growth. Accordingly, the MPC has adopted a prudent and cautious approach in this meeting to wait for better visibility on the growth and inflation outlook. A growth slowdown—if it lingers beyond a point—may need policy support. At present, it is necessary to draw on the flexibility provided by the neutral stance to wait for and monitor the incoming data for confirmation of the decline in inflation”

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

 

CPI Inflation (%)

GDP Growth (%)

8-Aug-24

9-Oct-24

6-Dec-24

8-Aug-24

9-Oct-24

6-Dec-24

Q1FY25

4.9A

4.9A

4.9A

7.1

6.7A

6.7A

Q2FY25

4.4

4.1

4.2A

7.2

7.0

5.4A

Q3FY25

4.7

4.8

5.7

7.3

7.4

6.8

Q4FY25

4.3

4.2

4.5

7.2

7.4

7.2

FY25

4.5

4.5

4.8

7.2

7.2

6.6

Q1FY26

4.4

4.3

4.6

7.2

7.3

6.9

 

Assessment of Inflation

The RBI revised its inflation forecast for Q3FY25 due to higher food price pressures in the near term. However, the Central Bank expects the headline inflation to moderate to 4.6% and 4% in Q1FY26 & Q2FY26, respectively on the back of a strong kharif harvest and a likely favourable rabi season. The RBI Governor noted adverse weather-related shocks and a rise in international agricultural commodity prices as upside risks to the RBI’s inflation forecast.

Assessment of Growth

The RBI remained optimistic about growth for FY25 and FY26, dismissing the 5.4% Q2 GDP growth as a one-off shock caused by idiosyncratic factors within manufacturing. The RBI Governor, in his speech, remarked that recovery is being seen in some high-frequency indicators, with the service sector remaining strong and Government consumption improving.

Liquidity Management 

We had expected liquidity to tighten (https://www.utimf.com/blogs/opening-stable-doors-update-rbi-monetary-policy-october-2024) on currency demand and FX interventions. We had also expected that the neutral stance would give flexibility to the RBI to act. High FX intervention and seasonal currency leakage had resulted in a meaningful decline in core liquidity from Rs. 3 lakh crs in Oct’24 policy to approximately 1 lakh crs currently. Without positive intervention, interbank liquidity could have moved into a meaningful deficit by the next quarter, inconsistent with the policy stance. The focus of today’s policy was on infusing durable liquidity with a 0.5% cut in CRR to 4.0%. However, this may not be enough in case FX flows continue to remain adverse. Hence, RBI may take additional steps like longer-term VRRs, FX swaps and even bond purchases in Q4FY25 to infuse liquidity.
  
However, today’s decision to cut the CRR to 4%—the level that prevailed pre Covid—should ensure that overnight rates remain close to the repo rate. This move also affords RBI the space to cut policy rates once it has stronger visibility on the decline in inflation.  

Outlook – Bond yields are at an attractive level 

Maintain expectations of a rate cut cycle of 50-75bps

We mentioned in our October ’24 policy review that a stance change despite a volatile global macro backdrop reflects RBI’s implicit acknowledgement of softening domestic growth. The use of a blunt instrument like a CRR, despite a backdrop of high inflation, reflects the RBI’s steadfastness to support growth and liquidity. Hence, we expect RBI to cut once it has a greater conviction on the decline in inflation, possibly by its February ’25 policy. We continue to see  space for 50-75bps rate cuts in the current monetary cycle. 

While near-term volatility may not be ruled out due to geo-political factors, bond yields—especially at the intermediate duration (1-5 years)—remain attractive. The curve can further steepen once the rate cycle begins.  
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.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.

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Date of Publication
09-Oct-2024
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Anurag Mittal
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Head-Fixed Income
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Anurag Mittal is the Head - Fixed Income at UTI Asset Management Company Ltd. He is a Chartered Accountant affiliated with Institute of Chartered Accountant of India and holds a degree in Master of Science from University of London. He previously held the office of Senior Fund Manager at IDFC Asset Management Company Private Limited and managed key IDFC debt mutual fund schemes. Prior to this, he was associated with HDFC Asset Management Company Limited as Senior Manager - Investments and Axis Asset Management Company Limited as Fund Manager - Investments, responsible for Fund Management, Dealing and Research.

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