RBI Monetary Policy: Dec 2024 RBI shifts focus towards growth

Today’s monetary policy event underscores the Reserve Bank of India’s (RBI) focus towards supporting growth. The central bank cut the CRR by 50 basis points to 4% in two equal tranches. This reduction will inject liquidity amounting to Rs 1,16,000 crore into the banking system, with an even larger multiplier effect. Although the central bank’s stance remains neutral, it’s noteworthy that two members voted for an interest rate cut, while four favored a pause, as compared to one member voting for a rate cut and five favoured a pause in the October policy.

We view this as a positive development following the GDP growth disappointment. Additionally, the RBI has lowered the GDP growth estimate for FY25 to 6.6%, with expectations of a rebound later. Similarly, the central bank has revised its inflation target upward to 4.8%, anticipating it to decrease subsequently.

As highlighted in our recently released Acumen “Is the best of banking liquidity behind us”, we emphasized that banking liquidity would be neutral to deficit for most part of January -March 2025 due to (1) Strong seasonal growth in currency in circulation, (2) Increase in Cash Reserve Ratio (CRR) maintenance on account of strong deposit growth in Q4 and (3) Build-up of Government balances in Q4. We highlighted that the RBI has multiple tools available such as CRR cut/ VRR/OMO operations to infuse liquidity in the banking system.

In such a scenario, the RBI’s 50 bps CRR cut makes the difference. The RBI has a cushion of 50 bps of additional CRR, maintained since May 2022. A CRR has been the most appropriate tool, as it would also help banks manage liquidity in light of the expected tweaks in LCR guidelines next year.

Policy Decision

• CRR cut by 50 bps to 4% in two tranches of 25 bps each


• Repo rate unchanged at 6.5%


• SDF rate unchanged at 6.25% and MSF rate & bank rate unchanged at 6.75%


• Four members voted in favor of the pause, while two members voted for an interest rate cut


• All members decided unanimously “to continue with the neutral stance and to remain unambiguously focused on durable alignment on inflation with the target while supporting growth”

Growth estimates cut while inflation projections revised higher across periods

The MPC noted that the the GDP growth came in sharply lower than expected as private consumption and investment decelerated even while government spending recovered from a contraction in the previous quarter. Looking ahead, robust kharif foodgrain production and good rabi prospects, coupled with an expected pickup in industrial activity and sustained buoyancy in services augur well for private consumption. Investment activity is expected to pick up. While headline inflation rose in the last two months driven by a sharp uptick in vegetable prices, food inflation is likely to soften in Q4 with seasonal easing of vegetables prices and kharif harvest arrivals.

However, risks stem from heightened geo-political uncertainties and financial market volatility. The RBI underscored the fact that high inflation reduces the purchasing power of both rural and urban consumers and may adversely impact private consumption. Accordingly, the central bank slightly modified the growth and inflation targets across time periods.

Source: RBI Governor’s Statement dated 6th December 2024

Higher interest rates on FCNR deposits to attract foreign inflows

In order to attract more capital inflows, the RBI decided to increase the interest rate ceilings on FCNR(B) deposits. Accordingly, effective from today, banks can now offer rates up to the Overnight Alternative Reference Rate (ARR) + 400 basis points for deposits with maturities between 1 year and less than 3 years as against 250 bps at present. Similarly, for deposits of 3 to 5 years maturity, the ceiling has been increased to overnight ARR plus 500 bps as against 350 bps at present. This relaxation will be available till March 31, 2025 and help in attracting forex inflows.

Introduction of the Secured Overnight Rupee Rate (SORR) – a Benchmark based on the Secured Money Markets

The RBI proposed introducing a new benchmark - the Secured Overnight Rupee Rate (SORR) - based on all secured money market transactions – overnight market repo as well as TREPS. This has been done with a view to further develop the interest rate derivatives market in India and improve the credibility of interest rate benchmark.

Market Reaction

While the markets did not expect a repo rate cut, the CRR cut was widely anticipated to ease liquidity in the banking system. Post the announcement, bond yields at the short end of the curve fell 3-4 bps while the long end saw a small upside in yields as CRR cut was largely priced in. The rupee appreciated around 15 paise on announcement of FCNR guidelines.

Our View

Policy commentary is in line with our view. We had been of the view that banking liquidity would remain largely in deficit for Jan- March 2025 quarter unless RBI intervenes in form of CRR cuts and the announcement today is indicative of the RBI being mindful of the deficit in the banking system.

The RBI governor sounded balanced in his views, and we agree that the neutral stance of monetary policy provides the RBI flexibility to monitor the progress and outlook on disinflation and growth and to act appropriately. We expect markets to rally by 8-10 bps across the curve and yields to trend lower as markets could start pricing in a 25 bps cut in February policy. Having said that, we expect no significant uptick in short term rates and hence should be rangebound. However, yields on government bonds could be lower staying in a range of 6.6-6.7% in anticipation of February rate cuts.

Why a rate cut in February is more likely?

We believe that from February, every policy meeting will be an opportunity for a rate cut based on the below

• By the next policy meeting, the central bank would have clarity on inflation and growth numbers to some extent


• The Union Budget would be rolled out and if government continues on the path of fiscal consolidation, which we believe it would, monetary easing will be the likely outcome


• Donald Trump would be sworn in as the President of the US on January 20, 2025 and by the time of our policy meeting, all the currency movements and market reactions would be priced in

Global economic outlook

The US Federal Reserve (Fed) has so far lowered the federal funds rate by 75 bps cut bringing it down to a range of 4.5% to 4.75% and we expect a further cut of 25 bps in December. Headline inflation in the US is expected to be ~2.75% for next 6-12 months and hence expect Fed to target Fed funds rate -3.5% by end 2025.

Risks to our view

We see currency as the only risk to our long duration view. Rupee can see some depreciation which can delay the rate cuts and lower the quantum of rate cuts too.

Allocation and strategy is based on the current market conditions and is subject to changes depending on the fund manager’s view of the markets. Data as on 30 November 2024

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DISCLAIMER

Source of Data: RBI Governor’ Statement, RBI Monetary Policy Statement & RBI post policy press conference dated 6th December 2024, Axis MF Research

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