In line with our and market expectations, the Monetary Policy Committee (MPC) of the RBI at its second bi-monthly meeting for FY25, maintained status quo on repo rate at 6.50%, while retaining its policy stance of ‘withdrawal of accommodation’.  This marked the eighth consecutive monetary policy review of no action on rates accompanied by an unchanged stance and the first such after the general elections outcome.

• Status quo on rates and stance was backed by 4 out of 6 MPC members. 
• Prof. Jayanth R. Varma and Dr. Ashima Goyal voted for a 25 bps cut and a change of stance to ‘neutral’, marking an interesting addition to the number of dissenters. 

Macro-Economic Outlook

With respect to FY25 economic outlook -

• The RBI upped its FY25 GDP growth forecast by 20 bps to 7.2%. On a quarterly basis, the central bank projects GDP growth at 7.3% in Q1 FY25 (revised up by 20 bps), 7.2% in Q2 FY25 (revised up by 30 bps), 7.3% in Q3 FY25 (revised up by 30 bps), and 7.2% in Q4 FY25 (revised up by 20 bps).
• Forecast for FY25 CPI inflation was retained at 4.5%. The quarterly forecasts were also retained at 4.9% for Q1, 3.8% for Q2, 4.6% in Q3, and 4.5% in Q4 FY25 respectively.

Key Regulatory and Supervisory steps

• After the enhancement done in 2019, the RBI has now proposed to revise the definition of bulk deposits as ‘Single Rupee term deposit of Rs 3 Cr and above’ for SCBs (excluding RRBs) and SFBs. Further, it is also proposed to define the bulk deposit limit for Local Area Banks as ‘Single Rupee term deposits of Rs 1 cr and above’, as applicable in case of RRBs. This could have a marginal pressure on either lending rates or NIMs of few banks.
• Amidst growing instances of digital payment frauds, the RBI has proposed to establish a Digital Payments Intelligence Platform for network level intelligence and real-time data sharing across the digital payments’ ecosystem. This system-wide entity would help prevent and mitigate digital payment frauds.
• In addition, the RBI Governor in his speech flagged the ‘high and usurious’ rates charged by few NBFC and MFI lenders on small loans. He urged all regulated entities to follow guidelines on Key Facts Statements and use the regulatory freedom judiciously to ensure fair and transparent pricing.

 Takeaways, Conclusion

Since the last policy review in Apr-24, the near-to medium term economic outlook has brightened somewhat. 

• Global growth continues to show resilience despite persistence of geopolitical uncertainty and record monetary tightening by key central banks. In case of India, leading indicators appear to carry forward the strong momentum from FY24 into Q1 FY25. Expectation of a surplus rainfall in the south-west monsoon season, continued thrust on public capex, and healthy balance sheets of corporates and banks augur well for economic activity. 
• Meanwhile, comfort on inflation prevails with the central bank continuing to project moderation in CPI inflation to a 6-year low of 4.5% in FY25. However, such a moderation is significantly dependent on:
  1. IMD’s forecast of 6% surplus rainfall during Jun-Sep 2024 along with relatively balanced intertemporal and spatial distribution will be helpful in lowering the pressure on food inflation.
  2. Moderation in international crude oil prices from an average of USD 90 pb around Apr-24 MPC review to USD 79 pb in Jun-24 MPC review is a significant relief for input price inflation.

While such a Goldilocks situation of resilient growth and moderate inflation has increased the likelihood for the continuation of status quo on monetary policy, we believe that we are gradually moving towards a pivot, as:

• The RBI’s Monetary Policy Report in Apr-24 had projected FY26 CPI inflation at 4.0%. This alignment of inflation with its target will create space for monetary easing in a frontloaded manner considering usual transmission lags.
• As per our estimates, FY25 GDP growth would moderate to 6.8% from 8.2% in FY24 after accounting for lagged impact of monetary, liquidity, regulatory, and fiscal tightening along with normalization of statistical boost that predominantly prevailed in FY24. Since this is lower than estimated by the RBI, this might increase the internal MPC divide in favor of monetary easing.
• Two out of six MPC members have already turned dovish as moderation in inflation is resulting in a step-up in real interest rates (for details, see – MPC Minutes: Warrants patience in policy pivot, Apr 20, 2024). If CPI inflation continues to get projected at sub 4.5% levels in the subsequent quarters, then the dovish clan could gain more support.
• Recent rate cuts by key central banks (BoC and ECB) underscore the point that monetary easing need not wait till inflation target is reached. Since the post pandemic monetary tightening was done at a record pace to counter high inflation, the resultant moderation in inflation 1-2 years down the line requires finetuning of policy rates. The absence of fine-tuning may raise real interest rates to a level where it will turn monetary policy incrementally restrictive, thereby resulting in output sacrifices.   

As regards the MPC opinion, the key uncertainty on inflation currently stems from food items, which has its roots in past weather disturbances along with the ongoing above-normal heat waves. The MPC would prefer to have these risks mitigated by the likelihood of surplus rainfall this year before changing the course of monetary policy.

As such, we continue to expect the MPC to maintain its anti-inflation posture in the next policy review in Aug-24. A pivot towards easing is likely in the subsequent policy review in Oct-24 or Dec-24. Overall, we expect a 50 bps rate reduction spread between Oct-24 and Feb-25 policy reviews. The expected rate easing cycle is likely to be shallow:

• The central bank is committed in ensuring inflation attains its target on a durable basis
• Real rates provide a limited latitude for downward adjustment
• Fiscal deficit is yet to align with its pre Covid lows

Liquidity and G-Sec View

In recent weeks, core liquidity (headline liquidity adjusted for government’s cash balances with the central bank) surplus has increased towards 1.9% of NDTL (Rs 3.97 trillion) on account of RBI’s record high dividend transfer. Since the RBI usually considers 1.5% of NDTL as a threshold for liquidity surplus getting inflationary, one could expect some policy action for mopping up this incremental surplus. While the central bank could deploy long dated VRRR auctions or use SDF window, the likelihood of an OMO sale cannot be ruled out either.

G-secs yields were stable amidst no major surprise in today’s policy outcome, with the 10Y yield currently trading at 7.02%. We continue to expect 10Y g-sec yield to moderate towards 6.75% levels by Mar-25, on the back of:

• Strong fiscal cushion provided by the record high transfer of RBI dividend, which could potentially result in some downside to the FY25 borrowing target
• Start of rate cuts by the RBI, as discussed above in fiscal third quarter
• Bond index related foreign buying (inclusion of Indian bonds in J P Morgan indices)

Says Suman Chowdhury, Chief Economist and Head – Research 

“With no surprises, RBI MPC has kept the status quo on the interest rates and the monetary stance for the eight consecutive time. It has continued to reaffirm its commitment to sustainable disinflation and price stability. The central bank would continue to watch out for any upward risks in food inflation in the near term, despite the forecast of an “above normal” monsoon. Further, it may also monitor the revised upcoming Union Budget to track the possible increases in welfare spend and its potential impact on inflation. 

The growth forecasts for RBI has been revised upwards to 7.2% from 7.0% earlier for FY25, reaffirming confidence in the strength of the domestic economy after a positive surprise of 8.2% GDP growth in FY24. RBI also appears upbeat about a recovery in private consumption in the current year, supported by a favourable monsoon. Its assessment on global growth and trade also remains positive despite the persistent geo-political risks. Our outlook on the domestic growth prospect nevertheless, is relatively moderate with a forecast of 6.8% for FY25, given the base factor at play.

On the inflation front, RBI has retained the CPI inflation forecast at 4.5% for the current fiscal while acknowledging the sticky nature of food inflation and the potential risks to fuel inflation, the latter being vulnerable to global developments.  

Regarding liquidity, the high dividend of Rs 2.1 trillion by RBI to the Government has been positive for short term interest rates. But we expect RBI to calibrate system liquidity appropriately and facilitate better monetary transmission through absorption of any excessive liquidity portion that may arise after the re-start of government spending and the expected inflows from debt FPIs amidst India’s inclusion in the JPM bond indices.  

Given the tone of the MPC statement and the expectation of stronger domestic growth, we believe that there is a limited likelihood of a rate cut by RBI in the current calendar year; such a probability, however, can increase in Oct-Dec’24 if the headline inflation settles around the 4.5% levels followed by a deceleration in the growth momentum.”