Robust manufacturing activity amidst easing input cost pressures, revival in construction and a gradual recovery in the rural sector bodes well for overall consumption demand
Fintech Biznews Service
Prerna Singhvi, CFA
Vice President – Economic Policy and Research
National Stock Exchange of India Limited (NSE)
Mumbai, December 8, 2023: The RBI’s Monetary Policy Committee (MPC)
unanimously decided to keep the policy repo rate unchanged at 6.5% and retain the
‘withdrawal of accommodation’ stance on a 5:1 majority, as the past rate hikes
continue to work their way through the economy. Even as the headline inflation has
fallen sharply since the last meeting, there are upside risks emanating from recurring
food price shocks and their implications on inflation expectations. Further, volatility in
crude oil prices and global financial markets pose additional risks. That said, the
headline inflation estimate for FY24 has been retained at 5.4% for the second
consecutive policy, falling to RBI’s mid-point target of 4% by the second quarter of
FY25. The RBI remained sanguine on the growth outlook and has revised its FY24
GDP growth estimate upwards by 50bps to 7.0%, moderating slightly to an average
of 6.5% in the first three quarters of FY25. While strong manufacturing and
construction activity, and gradual recovery in the rural sector is expected to improve
consumption demand, investment growth is expected to remain robust, aided by
healthy balance sheets of banks and corporates, and robust capex push by the
Government. Liquidity conditions remained tight in November, thanks to high festive-
led currency demand, and Government cash balances, nullifying the need of OMO
sales. That said, liquidity pressure is likely to ease going forward with a pick-up in
Government spending. The MPC’s decision on maintaining status quo on rates and
stance is in line with expectations, accompanied with a balanced commentary. While
the MPC reiterated its commitment to aligning inflation to the target, it also
highlighted the need for remaining ‘mindful of the risk of overtightening’ for the first
time in the current cycle. In the light of MPC’s comfortable outlook on growth and
undeterred focus on the 4% inflation target, we continue to expect a prolonged
pause. Until then, RBI is likely to continue to focus on liquidity management to
ensure liquidity conditions remain aligned with the monetary policy stance. • Status
quo on rates and stance: In line with expectations, the RBI’s MPC unanimously
decided to retain the policy repo rate at 6.5%, citing the need to maintain vigilance
given the upside risks stemming from food prices in the nearterm. Moreover, it
continues to monitor the impact of past rate hikes on the economy. With this, the
Standing Deposit Facility (SDF) and the Marginal Standing Facility (MSF) rates—the
upper and lower bounds of the Liquidity Adjustment Facility (LAF) corridor—remain
unchanged at 6.25%, and 6.75% respectively. The members also voted, with a 5:1
majority, in favor of keeping the “withdrawal of accomodation” stance intact, with
Prof. J. R. Varma expressing reservations for the ninth time in a row.
• Inflation forecast for FY24 retained at 5.4%: Moderating inflation conditions are
expected to sustain in the near-term with vegetable prices coming off and a sharp
cut in LPG prices. This, coupled, with softening of gobal commodity prices and
import dependent food products serves as a positive. That said, uncertainty around
food prices and Rabi sowing getting pushed-off due to delayed Kharif harvest poses
upside risks to the outlook. Further, recurrence of food price shocks and volatility in
crude-oil prices could result in second-order effects in the form of generalisation and
persistence of inflation. Taking these risks into consideration, the RBI has maintained
its inflation forecast for FY24 at 5.4%, retaining its Q3 and Q4 forecast at 5.6% and
5.2% respectively. Assuming a normal monsoon next year, CPI inflation is projected
at 5.2% in Q1FY25, falling to 4% in Q2FY25, only to rise marginally to 4.7% in
Q3FY25.
• GDP growth revised up by 50bps to 7%: Even as global economy remains fragile,
domestic growth outlook has exhibited resilience, thanks to durable urban
consumption demand and strong Government spending. Following a significant
positive surprise in Q2, the RBI revised its FY24 GDP growth forecast upwards by
50bps to 7%, with Q3 and Q4 figures revised up to 6.5% (+50bps) and 6% (+30bps)
respectively. The momentum is expected to sustain in FY25, with growth forecast
pegged at 6.7% in Q1FY25, 6.5% in Q2FY25 and 6.4% in Q3FY25. Robust
manufacturing activity amidst easing input cost pressures, revival in construction and
a gradual recovery in the rural sector bodes well for overall consumption demand.
Investment growth is also expected to remain robust, aided by improving business
confidence and robust capex spending by the Government. Further, healthy balance
sheets of banks and corporates provide a conducive environment for a steady
recovery in private capex. Key downside risks to the growth outlook may emanate
from a weaker-than-expected external demand, heightened geopolitical tensions and
strengthened financial market volatility.
• Focus remains on liquidity management: After falling into deficit in September for
the first time in 4.5 years, systemic liquidity remained in deficit for a large part of
October and November, thanks to strong festival-led currency demand, higher
Government cash balances and liquidity operations by the RBI. After OMO (open
market operations) sales amounting to Rs 85.9bn in October 2023 following the last
policy announcement, tighter-than-expected liquidity conditions in November
precluded RBI from undertaking further OMO sales. While average borrowing
through MSF increased from Rs 946bn in Sep’23 to Rs 1.2trn in Oct-Nov’23, money
parked in overnight SDF declined from Rs 760bn in Sep’23 to Rs580bn in Nov’23,
indicating a decline in the skewness of liquidity even as conditions continue to
remain tight. That said, liquidity pressure is likely to ease going forward with a pickup
in Government spending.
• Prolonged pause for now: While the pause on rates and stance was widely
expected, the commentary became much more balanced vis-à-vis a hawkish rhetoric
in the previous three policies. Even as the Governor reiterated MPC’s commitment to
aligning inflation to the 4% target, he also cautioned against the “risk of
overtightening” which looks like a first step towards moving to a neutral stance. In the
light of MPC’s comfortable outlook on growth and undeterred focus on the 4%
inflation target, we continue to expect a prolonged pause. Until then, RBI is likely to
continue to focus on liquidity management to ensure liquidity conditions remain
aligned with the monetary policy stance.
Movement in key policy rates
The policy repo rate was retained at 6.5% in the December policy, accompanied with
continuation of “withdrawal of accommodation” stance. Call money rate exceeded
the repo rate after the previous policy announcement that followed OMO sale by the
RBI. It further increased in November to 6.8% (30bps above MSF) after the
announcement of the increase in risk weights on NBFCs.
Net lending under RBI’s Liquidity Adjustment Facility
Net systemic liquidity remained mostly in deficit throughout October and November,
with liquidity injections through the LAF peaking at Rs 1.8trn on November 22nd, the
highest since Dec’18.
Change in yield curve on the policy day and in FY24 thus far (As on December
8th, 2023)
Yields have hardened across the curve since the last policy following the OMO sales
in October and increase in risk weights for NBFCs in November.
India vs. US policy rates and yield differential
Softening in global yields has resulted in widening of spreads between India and US
bonds.
India’s consumer inflation trajectory and RBI’s forecasts
The RBI maintained the headline CPI inflation forecast for FY24 at 5.4%. Further,
RBI expects inflation to decline to 4% in Q2FY25 while increasing to 4.7% in the third
quarter.
GDP growth trend and RBI’s estimates
The RBI has turned sanguine on the growth outlook and has revised its FY24 GDP
growth estimate upwards by 50bps to 7.0%. The forecast for Q3FY24 and Q4FY24
have also been revised upwards by 50bps and 30bps respectively from the last
policy. The momentum is expected to sustain in FY25, with growth forecast pegged
at 6.7% in Q1FY25, 6.5% in Q2FY25 and 6.4% in Q3FY25.
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