With the improvement in the macro environment, the Reserve Bank of India (RBI) is expected to maintain the status quo on rates and keep them on hold when it shares the outcome of the monetary policy committee (MPC) meeting on June 8. The focus will largely be on any change in the stance of "withdrawal of accommodation".
In the previous meeting on April 6, MPC unanimously decided to keep the policy repo rate unchanged at 6.5 percent while emphasising that the decision to pause the repo rate was intended for the current meeting only and that it would not hesitate to take further action as would be required in future meetings.
Inflation picture
After the April MPC meeting, the Federal Open Market Committee (FOMC) unanimously decided to raise the target range for federal funds rate by 25 bps to 5 to 5.25 percent with a mild tint of dovishness.
The inflation in the US seems to be at an inflection point, with policy rates just moving in the positive real rate zone. While inflation is moderating, the release of the May employment report exceeded expectations as employers added 339,000 jobs across a broad set of industries.
Strong macroeconomic data and FOMC members commentary has resulted in the market expecting one more hike and pushing the rate cuts to the end of CY 2023. Though we are close to the peak Fed Fund Rate, the near-term path is unclear.
Inflation in the UK is still very high at 8.7 percent for April, twice the US rate (4.9 percent) and significantly higher than the Eurozone’s 7 percent, which slowed to 6.1 percent for May. Hence policymakers in the UK may need to take some more policy action in terms of a hike in interest rates before a pause.
In India, the headline CPI is tracking 70 bps below the RBI’s forecasts over the next two quarters and is expected to average 4.6 percent in the first half of FY24. Hence, RBI’s CPI projection of 5.2 percent for FY24 is likely to undershoot for the year.
Core Inflation has also softened from 6 percent in H2 FY23 to 5.19 percent in April 2023, facilitated by a softening of input cost pressures for goods but also, surprisingly, soft services inflation. Risks do exist to inflation in the coming months, principally from the manifestation of El Nino and its impact on monsoon rains.
India's GDP grew by 6.1 percent in Q4FY23 and FY23 GDP growth is pegged at 7.2 percent, beating expectations. India continues to be one of the fastest -growing economies in the world.
Liquidity situation comfortable
The liquidity has eased to comfortable levels in recent days, with the currency in circulation declining, the government ramping up spending, and the RBI building back forex reserves. It implies no other action such as Open Market Operations (OMO) or Cash Reserve Ratio (CRR) cut may be needed to manage liquidity in the near term.
India is in a Goldilocks scenario with strong GDP numbers and moderation in inflation. The upcoming decision of MPC goes beyond the usual deliberations of interest rate hikes or pauses. Instead, it revolves around whether the MPC will pivot towards a "neutral" stance or continue with the current stance of "withdrawal of accommodation".
Considering the uncertainty about the path of Fed rates in the coming months and the risk to inflation due to El Nino, our perspective leads us to anticipate a dovish message from the MPC, implying that the RBI has concluded its tightening measures, all while maintaining the existing monetary policy stance.
The next MPC meeting is in August, by which time the RBI would have more clarity on the Fed rate path and by then, El Nino risk would also have played out. Hence, the RBI may choose to continue with the current monetary policy stance and change to neutral in the August 2023 policy.
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