Apr 05, 2024 MPC_ Is it time to change the Monetary Policy Stance ???

The MPC is scheduled to announce the interest rate decision on April 5, 2024

Expectations:

Interest Decision

No change expected, 6.25% - 6.50% - 6.75% (SDF - Repo - MSF)

Policy Stance

With FY25 Inflation estimates at 4.40% and RBI Policy Rate at 6.50%, RBI is well into restrictive territory with Real Rates on a Forward-Looking basis at over 2%. A whole new discussion around higher Neutral Rates has espoused as growth has consistently outpaced expectations. PMIs have been in expansion territory and credit growth has been robust at an average 15.39% for the calendar 2023. Expectations into FY25 growth are robust with through the year growth seen at 7.40% and FY24 growth seen clocking 8%.

Outlook for inflation is benign with through the year inflation numbers likely in the vicinity of the lower band of the 4% - 6% target. According to RBI Monthly Bulletin, FY 25 , Inflation is projected at 4.40% for full year with inflation at 4.7% in Q1 and gradually declining towards 4.30% by the end of the year. Fuel prices are likely to remain in deflation on a Rs. 100 reduction in the price of LPG and Rs.2 reduction in retail selling prices of petrol and diesel in March. Risk to food inflation persist.

RBI has been trying to carefully traverse the Domestic growth trajectory by limiting the risk build up in the banking sector through Macro Prudential Regulations like increasing the risk weights on unsecured personal loans, credit cards and lending to NBFCs / timely Regulatory interventions in case of NBFCs, Payment Banks etc.

Monetary Policy Transmission is still incomplete. Please refer to the table below from RBI monthly bulletin.

Considerable Uncertainties remain in terms of crude oil price and vegetable prices outlook, monsoon and growth in the agriculture sector, geopolitical tensions and the consequent supply chain disruptions. India will also have the General Elections, results of which will be announced on June 4 and the impending bond index inclusion.

A change in stance alongside positive demand supply dynamics of the Government’s borrowing program is likely to see a Pavlovian Response from the Rates markets. Currently, the OIS markets are pricing in 33 bps of rate cuts into the next 1 year and 10Y Gsec has been gradually moving lower towards the 7% handle.

My argument is predicated on how a change in stance would loosen financial conditions and tighten credit spreads when considerable uncertainties remain and hence I think RBI may choose to defer the change of stance to the next policy or policy after. 5Y AAA Corporate Rate spreads over risk free rate has declined from 75 to 64 bps between 12 Jan 24 and 13 Mar 24.

This would allow RBI more breathing room to manage the exchange rate while the Economic Uncertainties resolve. Also a more conservative strategy would likely coincide the timing of change in stance to more certainty on timing of the first cuts from the Federal Reserve.

A risk management approach to Policy making favors RBI maintaining the stance as Withdrawal of Accommodation. However, the benign inflation outlook and broad consensus that we are at peak interest rates, favor a change in policy stance.

Comments

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