April 2024 RBI policy may stay on “wait and watch” mode

4 Apr 2024 , 10:10 AM

LAST MONETARY POLICY BEFORE THE GENERAL ELECTIONS

Between the April 2024 monetary policy and the June 2024 monetary policy, the world’s largest democracy will go to vote. Elections in India are never an easy proposition considering her geographical and cultural vastness and diversity. However, the one thing it does imply is that the RBI Monetary Policy Committee (MPC) may not want to do anything disruptive at this point of time. Hence, the focus may be more on maintaining status quo on all the monetary variables. The RBI is unlikely to even change the key projections for FY25 as of now; be it liquidity, or inflation estimates. However, the one area that may see upgrades is the GDP growth, where the RBI has been quite conservative compare to the robustness in the MOSPI numbers.

There have been numerous estimates on when the RBI will effect its first repo rate cut. After all, the RBI gave up its hawkish approach in February 2023 and the April 2024 policy will be the seventh policy when rates have not changed. In April 2024, rate cuts are likely to be influenced by extraneous factors, rather than by macro variables. For example, the RBI may not want to tinker with rates till the elections are completed towards end of May and a new government is in place. Even after that, the RBI may prefer to wait will the full budget is presented around July 2024 before embarking on any rate decision. In short, rate cuts (if any), are likely to be considered only towards the end of the second quarter or in the third quarter of FY25.

 

HOW MACROS SHAPED UP SINCE THE FEB-24 MONETARY POLICY?

The February 2024 monetary policy statement had maintained its estimates across the board, except for raising its FY25 estimates for GDP growth.

• Between the February 2024 monetary policy and the April 2024 monetary policy, the big announcement was the GDP estimates for the third quarter. It was a big positive surprise as the third quarter GDP growth estimate came in at 8.4%. What is more, the GDP growth estimates for Q1 and Q2 were also upgraded to 8%. In that light, the full year FY24 GDP estimate of 7.6% looks too conservative. In fact, most private estimates post the GDP announcement are pegging GDP growth for FY24 at closer to 8% and for FY25 at closer to 6.8-7.0%.
• US Fed policy on the rates front has been rather ambiguous in the last few months. Late last year, the US Fed had hinted at 3 rate cuts in the year 2024 and 4 rate cuts in 2025. However, the CME Fedwatch is now hinting at a 50% probability that the Fed may only attempt 2 rate cuts in 2024 and 3 rate cuts in 2025. That is because, the last mile inflation is proving to be much stickier than originally imagined. It now looks very likely that the US may commence rate cuts only after June 2024.
• Between the February policy and the April policy, the liquidity deficit in the Indian economy has come down from ₹3.50 Trillion to below ₹1 Trillion. There is likely to be a surge in liquidity in the economy during elections and the RBI April 2024 policy would be conscious of that. This is the last monetary policy ahead of the election since the government should already be in place by the time of the June monetary policy. The focus may be in ensuring that liquidity does not get too tight in the Indian economy or too liberal, in a way that could trigger inflation.
• A major data point since the last policy announcement was the current account deficit (CAD) number. The current account deficit for the third quarter came in at $10.5 Billion or 1.2% of GDP. As of the close of the third quarter, the CAD stood at $31.5 Billion or 1.2% of GDP for the cumulative 9 months. However, with the services surplus likely to almost offset the merchandise trade deficit, the net accretion to CAD in the fourth quarter is likely to be just around $3.5 Billion. That means; full year FY24 CAD would be around $35 Billion or just under 1% of full year GDP. That is a lot more comfortable that could have been envisaged at the start of the year.
• One big trend in the last 2 years was the frenetic rise in central bank accretion to gold reserves. It is estimated that overall central bank gold holdings stand at 7,600 tonnes, of which around 2,100 tonnes got added in the last 2 years alone. Not surprisingly, the gold prices are at a lifetime high of $2,301/oz.

It is in this backdrop that the RBI Monetary Policy Committee will announce the first monetary policy of FY25 on April 05, 2024. Here is what to expect.

 

WILL THE RBI ATTEMPT RATE CUTS IN APRIL 2024

RBI kept rates at the current level of 6.5% since February 2023. The RBI has already stated in, no uncertain terms, that rates may have peaked out. Hence any rate hikes are totally ruled out at this point of time, or even later in this cycle. Regarding rate cuts, there are 2 reasons for the RBI to cut rates. Firstly, the inflation has now stabilized around 5% while the repo rates are still about 135 bps above the pre-COVID rates. That makes a case for rate cuts, but the RBI is unlikely to act on rates now as the inflation rate is still well short of the long term equilibrium rate of 4%.

However, the RBI decision to hold status quo on rates in the April 2024 policy will also be driven by more pragmatic considerations. The RBI would not want to attempt any rate cuts at a time when the elections are round the corner. Ideally, the RBI would prefer to wait till the elections are completed, the new government takes office, the cabinet members are appointed and the full budget is presented in parliament. That is likely to only happen by July this year, so any rate cuts till that time looks unlikely. That will also approximately synchronize with what the US Fed intends to do on the rates front.

 

IS THERE A CASE FOR THE RBI TO CHANGE MONETARY STANCE?

In the last several MPC meetings, one member who has had a counter view is Dr Jayanth Varma. According to Varma, the current monetary stance of “gradual withdrawal of accommodation” was not in sync with the overall financial system liquidity, which had been in deficit for some time. However, that argument may have mellowed now, considering that the liquidity deficit has come down from ₹3.50 Trillion at the time of the last policy to less than ₹1 Trillion now. Hence, the shift in stance may not really be taken up in April 2024.

The RBI will be more calibrated in shifting its monetary stance. What is more likely is that it would first shift its stance to neutral before it can shift to a more dovish stance. However, that is unlikely to happen before there is greater clarity on food inflation when the first estimates of the monsoons this year come in. Also, the liquidity in the system is likely to normalize post the elections and that is when the RBI may even consider any change in the stance. For now, it looks like RBI may maintain status quo on its monetary stance too.

 

IT MAY BE TOO EARLY TO CHANGE INFLATION ESTIMATES

The RBI had hiked the inflation target for FY24 by 30 basis points from 5.1% to 5.4% in its August monetary policy. Since then, there has been no change in the inflation outlook. Laster, the FY25 inflation target was pegged at 4.5%, a good 90 bps below the FY24 target. For FY24, as per data for the full year, it does look like 5.4% full year inflation was achieved. The question is whether the RBI would look to cut the estimates for FY25 from the current 4.5%. Or, would the RBI prefer to hike the inflation estimate at this juncture, considering the long term repercussions of the Red Sea crisis? Remember, the Red Sea crisis has spiked freight rates and insurance premiums, resulting in substantial imported inflation.

For now, any change to the inflation estimate looks unlikely. While core inflation has genuinely come down, that is more due to the normalization of the supply chain constraints. What the RBI would be focusing on now is the food inflation estimates; and for that it would be closely looking at the monsoon estimates for the Kharif season and the likely acreage for this year. In the last few months, even as core inflation and fuel inflation have moderated, it is food inflation that has been the big headwind for the Indian economy. The RBI, for now, is likely to maintain status quo on FY25 inflation estimates at 4.5%.

 

GDP UPGRADE FOR FY24 LOOKS CERTAIN, FY25 UPGRADE POSSIBLE

The India growth story is something the government of India has loved to highlight and the Indian economy has not disappointed, despite all the global and domestic headwinds. It looks like a unique amalgam of policy and momentum but growth appears to be on a high. For now, the FY24 growth estimates of the RBI at 7.0% are well below the NSO estimates of 7.6%. It is likely that the RBI may take the lead in pushing the FY24 estimates of GDP growth closer to the 8% mark. However, the hike to GDP growth estimates for FY25 is likely to be a lot more calibrates. The FY25 GDP growth estimates are already at 7.0% and most of the global brokerages and rating agencies have assigned a best-case growth rate of 6.8% for FY25. However, the India growth narrative appears to have sharply changed after the Q3 GDP numbers and that could reflect in the current monetary policy. So, apart from a sharp upgrade to FY24 GDP growth, even FY25 may see a marginal upgrade.

 

ADDRESSING GOLD LOANS AND THE C/D RATIO

Over the last few months, one big challenge for the RBI has been that deposits of the banking system have been growing much slower than the credit growth. That has continued in the last quarter also. However, for FY25, that gap is likely to narrow from the current 500 bps to around 150  bps as banks are likely to hike deposit rates to attract more people to park monies in the bank. That is not really happening now.

The other policy shift could happen on the gold loans front. Gold prices at $2,301/oz is at a lifetime high and is likely to fuel a lot of speculation with gold loans playing a part. The RBI has already clamped down on NBFC gold lending and on bank gold lending procedures. The policy could see more stringent measures to ensure that rising gold prices do not create a bubble like situation in the Indian economy.

 

RBI IS LIKELY TO STAY AMBIGUOUS ON THE RATE GUIDANCE

One thing the markets have been expecting from the RBI is some clarity on the direction of rates. Even though it is evident that the RBI is unlikely to even consider rate cuts before July this year, the markets are optimistic about the RBI giving some guidance on the timing and quantum of rate cuts. Especially, considering that repo rates are still 135 bps above the pre-COVID rates. Obviously, RBI may not be able to give explicit affirmation on this front, but the actions of the RBI in the recent past is testimony that RBI would not venture to even talk about rate cuts, till there was clarity on the inflation front.

Consequently, any expectations of RBI guidance on rate cut trajectory may be premature at this juncture and should not be expected. RBI does not give longer term projections considering the volatile nature of prices and liquidity in India. However, the subtle message from the RBI has been that any rate cuts may be considered only after the monsoon impact on Kharif was clear by August 2024. That would mean; rate cuts can be expected, at best, by the end of second quarter of FY24 or early third quarter.