RBI Monetary Policy: Rates unchanged, growth forecasts upgraded

Concurrent to our view, in its second policy of FY25, the Reserve Bank of India (RBI) retained a pause on interest rates for the eighth consecutive time. With headline inflation above the 4% target, the central bank governor persisted with its withdrawal of accommodation stance. However, two members voted for an interest rate cut, while four remained in favour of a pause. The RBI upgraded GDP growth for FY25 at 7.2% and maintained its inflation target at 4.5% but added that it will remain vigilant to the evolving outlook particularly the last mile inflation which remains high. The central bank also added that while they do look up to the US Federal Reserve, policy actions are solely based on changing domestic inflation conditions and outlook.

Policy Decision

• Repo rate unchanged at 6.5%


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


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


• Four members voted to “remain focused on withdrawal of accommodation to ensure inflation progressively aligns with the target, while supporting growth”

Growth estimates revised slightly upwards

The MPC noted that the outlook for domestic economic activity remains resilient on the back of strong domestic demand and improved macroeconomic fundamentals. An above normal monsoon coupled with a sustained momentum in manufacturing and services could help a revival in private consumption. Furthermore, the currency has largely remained stable and there has been a notable improvement in India’s external position with the moderation in the current account deficit (CAD), revival of capital flows, and rising foreign exchange reserves. The central bank maintained inflation targets as is and slightly enhanced growth numbers over all time periods noting that food prices remain elevated even as fuel prices fell.

Source: RBI Governor’ Statement dated 7^th June 2024

Market Reaction

The policy maintained a status quo and no change in liquidity stance. Headline policy action was in-line with market consensus. Bond Market yields have broadly remained unchanged with no meaningful movement in yields across the curve.

A few days back, the RBI paid a higher than expected dividend payout of Rs 2.1 trillion to the government, vs the expected Rs 0.9 trillion. We had anticipated this could likely lead to lower market borrowings and cut in Fiscal deficit for FY 25 from 5.1 to 4.9% of GDP. Additionally, it will also improve banking liquidity and would be positive for bond market yields.

However, post the announcement of electoral outcomes, we believe that the fiscal consolidation plan may get delayed and don’t expect any meaningful cut in borrowing for FY 25, and instead the government may spend that money on welfare schemes.

Our View

Policy commentary is in line with our view. The RBI is comfortable with the inflation trajectory and expects it to fall in the second half of the year. Growth has been strong and the external situation remains robust. Accordingly, the RBI will be in a watchful mode and would lower interest rates based on the evolving scenario.

With policy rates remaining incrementally stable, we remain long duration across our portfolios within the respective scheme mandates. RBI could effectively use liquidity manage tools such as VRR and reverse repos to manage durable liquidity.

From a strategy perspective, the overall call is to play a falling interest rate cycle over the next 6-12 months. Accordingly, investors should continue to build and hold duration across their portfolios. In addition, investors should be patient for further rally as rate cuts have been delayed to H2FY25. With positive demand supply outlook for bonds, FPI flows via JP Morgan Indices starting June 2024 and possibility of a lower government borrowing in July, investors could use this opportunity to invest in Short to Medium term funds with tactical allocation to gilt funds.

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 31^st May 2024

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Disclaimer

Source of Data: RBI Governor’ Statement, RBI Monetary Policy Statement & RBI post policy press conference dated 7^th June 2024, Axis MF Research

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